What Are Current Assets?
In the world of accounting the term “current assets” refers to assets that can be converted to cash within one year. These are the assets that your business would use in its everyday activities, or that you would personally use to maintain your daily finances. For making ends meet, these are hands down the most important assets you have; when you’ve amassed enough in current assets to get by and fund emergencies, then your focus can shift toward long-term assets and growing wealth.
Understanding Current Assets
In terms of personal finance, your current assets will mainly be composed of your instant cash accounts: checking and savings. While technically it would also include time-locked savings like three-, six-, or twelve-month CDs (certificates of deposit, which may pay slightly higher interest rates than “unlocked” savings), many financial advisors caution against using that money before its time, since doing so might trigger a penalty for early withdrawal that can strip away the interest you earned.
Another technicality: investments (like stocks and mutual funds) count as liquid assets because they are generally easy to cash in quickly. But most people are better off not counting on these as current assets because their values can be unpredictable and because of the commissions charged when they’re bought and sold.
For a small or startup business, current assets can make the difference between staying afloat and folding. If a company can’t pay its bills, it won’t be able to stay in business long. That’s why properly managing current assets is the key to early success. Using current assets like cash, accounts receivable, inventory, short-term investments, and prepaid expenses in the most advantageous manner possible can help your fledgling business survive and thrive.
Types of Current Assets
Many assets are considered current assets by various companies in all industries. Most industries usually group their current assets into these subaccounts; however, you may see others:
- Cash and Cash Equivalents
- Marketable Securities
- Accounts Receivable
- Prepaid Liabilities/Expenses
- Other Short-Term Investments
Current asset sub-accounts are usually shown on the balance sheet in order of liquidity of current assets. The finance department or accounting firm that prepared the report prioritizes the assets that can most easily be converted to cash. Since each company accounts for the included assets differently, the order in which these accounts appear may vary.
Cash and Cash Equivalents
Cash is an important component in Current Assets account. The most common cash equivalents are certificates of deposit, money market funds, and short-term government bonds.
Once your business is off the ground, you may actually find yourself with a cash surplus. But that surplus can dissolve as quickly as it grew, due to product or service obsolescence, economic changes, or changes in your personal situation.
Keeping the cash in the business can cushion your company against setbacks. Cash itself, though, doesn’t work very hard these days, as savings account interest rates currently hover near zero.
In the Marketable Securities account, the total value of liquid investments that can be converted to cash without losing market value is entered. For example, if a company’s stock is very thinly traded, it may be impossible to convert it to cash without affecting its market value. Since these shares are not considered liquid, their value is not recorded in the current assets account.
Accounts receivable is often the largest current asset for service businesses, and among the largest for inventory-based businesses. This account describes itself perfectly: It’s the amount of money you expect to receive from customers who made purchases on account. That does not include credit card sales—those count as cash. Rather, accounts receivable comes into play when your company itself extends credit to customers.
For example, if you’re a freelance writer and you write an article for a client, then submit a bill to them, the amount due in that bill would be included in accounts receivable. The situation is similar for inventory-based businesses. Say your company makes custom standing desks for $500 each.
A legal firm in town buys 10 desks, on account, for a total purchase of $5,000. Your company delivers the desks, and sends them an invoice. Your invoice would include the price of the desks ($5,000), plus sales tax (at 5 percent: $250), plus your $50 delivery fee. That inclusive invoice total of $5,300 ($5,000 + $250 + $50) would now be included in accounts receivable.
Managing your accounts receivable well can keep you in business; extending too much credit or letting customers slide can crush your company. No matter how much you want to make a sale, it’s important to make sure your customers are going to pay you. This can be easily resolved by having your customers fill out a credit application when you first start doing business with them.
That can provide valuable clues into a customer’s payment history, and let you know how likely they are to pay you. In the meantime, for their first purchase, you can extend limited credit (as much as you could stomach losing) or require a large down payment.
Companies that sell products need products to sell, and that means inventory. Whether you’re selling ready-made goods, products that you have to assemble be- fore selling, or products that you make, every component that goes into the items you’re selling counts in inventory.
Once you have inventory, you also have to track it, and that can be tricky because (if you’re lucky) this asset will move very quickly. Knowing your inventory numbers at all times is crucial to your company’s success. After all, if you don’t know how much you started with, how much you sold, and how much you have left on hand, how will you know when and what quantity to reorder?
Having too little inventory can frustrate customers, and turn them into former customers; think of how annoyed you get when items you want are out of stock (especially if a quick web check indicated it wasn’t).
On the other hand, having too much inventory on hand can drag your business down when it ties up too much of the company’s cash and takes up space for other items that move more quickly.
The best small business accounting software lets you easily follow inventory from the loading dock to the customer invoice. If the software you’re using isn’t as robust as you’d like, then you should find an inventory management app that can link with your accounting software. (A good example is SOS Inventory— www.sosinventory.com—which connects directly with QuickBooks in the cloud.) However you track your inventory electronically, you still may want to do periodic
physical counts, especially if your inventory is prone to breakage (or is easy to pocket).
Prepaid expenses crop up for small and startup businesses more often than you’d think. As the name implies, this account holds the balance of expenses you pay ahead of time, and will use up later. For example, your company may pay six months rent up front for its office space. Other common prepaid expenses include insurance, legal fees, and office supplies.
When a portion of the expense is actually used up, like one month’s rent out of that six-month prepayment, that’s when the expense gets recorded, reducing the prepaid asset account by the same amount.
Here’s how it works: When your company pays the landlord $6,000 for six months rent in advance, you’d record a $6,000 increase (debit) to prepaid rent, and a $6,000 decrease (credit) to the cash account. At the end of the first month, the company will have used up one month’s worth of rent, or $1,000. The entry to record that would increase (debit) the rent expense, and decrease (credit) the prepaid rent account.
Other Short-Term Investments
Many businesses turn to the stock market in the hopes that they’ll rack up some extra profits before they need that money back.
These short-term investments count as current assets for two key reasons. First, they’re highly liquid, meaning you can sell them fast and convert them back into cash without breaking a sweat. Second, they’re not part of a long-term plan, and they’re not locked up in something that can’t be sold quickly.
Though stocks are sometimes the preferred short-term investment, this category could include bonds, mutual funds, ETFs (exchange-traded funds), or any other investment that’s easy to flip at a moment’s notice.
Current Assets vs. Non-Current Assets
Non-current assets cannot be converted to cash within one year, while current assets can be converted to cash within one year. On a balance sheet, some of the same assets may be listed under current assets and fixed assets. Such assets may not be able to be sold within one year or at a substantially lower price than the purchase price if they are not marketable securities.
The sale of land, plant, buildings, fixtures, equipment and other illiquid assets may take a considerable amount of time. Since fixed assets are held for a long period of time and depreciate, they are also valued at their acquisition price. There is no depreciation for current assets.
The Formula for Current Assets
The formula for current assets is calculated by adding up all balance sheet assets that can be converted into cash within one year or less. Cash, cash equivalents, accounts receivable, inventories, marketable securities, prepaid expenses, etc. are examples of current assets.
Current assets are generally listed on a company’s balance sheet in descending order of liquidity, with cash being the most liquid form of current assets, i.e., easily converted to cash. These current assets are crucial components of a company’s short-term liquidity and net working capital.
Current Asset Formula is represented as:
Current Assets = Cash and Cash Equivalents + Accounts Receivables + Inventory + Marketable Securities + Prepaid Expenses + Other Liquid Assets