What are Current Assets?
The Current Assets categorization on the balance sheet represents assets that can be consumed, sold, or used within one calendar year.
- What is the definition of a current asset?
- How are current assets ordered on the balance sheet?
- What makes current assets different from non-current assets?
- How can we measure the financial stability of a company using current assets?
Current Assets on the Balance Sheet
Only assets that can be converted into cash within one year are classified as current assets, and they are often used to measure a company’s short-term financial health.
Current assets are also ordered from most liquid to least liquid on the balance sheet.
The main types of current assets include:
- Cash & Cash Equivalents – Cash on hand, currencies, and other short-term assets such as checking accounts and treasury bills with maturity dates of three months or less.
- Marketable Securities – Short-term investments that can be converted to cash, such as money markets and certificates of deposit.
- Accounts Receivable – Cash payments owed to the company by its customers for products or services already delivered.
- Inventory – The raw materials that go into making a product, as well as units in production and finished goods.
- Prepaid Expenses- The value of goods or services that the company has paid for in advance but not yet received.
Current Assets vs. Non-Current Assets
Together, current and non-current assets form the assets side of the balance sheet, meaning they represent the total value of all the resources that a company owns.
Non-current assets, or long-term assets, cannot reasonably be expected to be converted into cash within one year.
One important rule to note when accounting for long-term assets is that they appear on the balance sheet at their market value on the date of purchase.
Thus, unless deemed to be impaired, their reflected value will remain unchanged on the balance sheet even if the current market value is different from the initial purchase value.
Measuring Liquidity with Current Assets
A company’s liquidity refers to its ability to meet its short-term financial obligations, and it can be measured using the company’s current assets.
If the company has enough liquid assets (i.e. current assets that can be quickly converted to cash without losing too much value) to cover its current liabilities, then it is considered liquid.
If the company does not have sufficient liquid assets and cannot sufficiently cover its current liabilities, then it is considered illiquid, which is typically a major red flag to investors and creditors.
Investors can gain a number of insights into a company’s financial strength and future prospects by analyzing current assets, and investors often use various ratios to assess the value of a company’s current assets, including:
- Current Ratio – Measures a company’s ability to meet its current liabilities using its current assets.
- Current Ratio = Current Assets / Current Liabilities
- Quick Ratio- Measures a company’s ability to quickly pay off its current liabilities using its cash and highly liquid cash-like assets.
- Net Working Capital (NWC) Ratio – Portrays the additional funding the company has available for financing operations in relation to the size of the company.
- Net Working Capital (NWC) Ratio = (Current Assets – Current Liabilities) / Total Assets
- Cash Ratio – Measures a company’s ability to immediately cover its current liabilities using just its cash on hand.
- Cash Ratio = Cash & Cash Equivalents / Current Liabilities