What Are Current Assets?
Current assets are economic resources which the firm expects to sell, convert to cash, or consume within the greater of one year or the firm’s operating cycle.
Current assets include cash and equivalents, accounts receivable (also called trade receivables), notes receivable, inventory, and prepaid expenses.
Items on the balance sheet are presented in order of liquidity. Therefore, current assets are presented before long-term assets. The first account presented on the balance sheet is always cash and equivalents, as these assets are the most liquid.
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Why Current Assets Matter
Current assets are important to creditors since current assets are an important part of a company’s liquidity. Many common credit ratios utilize current assets.
Operating and Financial Current Assets
For analytical purposes, although not for financial reporting purposes, current assets may be divided into operating current assets and financial current assets.
Operating current assets are those current assets that correspond to the firm’s operating activities. Operating current assets include trade receivables, inventory, and prepaid expenses.
Financial current assets are those current assets that are associated with the company’s immediate liquidity or that correspond to the firm’s investing activities. Financial current assets include cash and equivalents, short-term investments, and notes receivable.
Current Assets and Working Capital
Current assets are an important component of a firm’s working capital (also called net working capital).
Working capital is broadly defined as current assets minus current liabilities. However, we can also calculate operating working capital.
Operating working capital is defined as operating current assets minus operating current liabilities. Operating working capital is an important item in cash flow forecasts.
Example of Current Assets
Consider a company preparing its balance sheet at the end of an accounting period.
The company reports the following accounts:
Cash and cash equivalents: $50,000
Accounts receivable: $30,000
Inventory: $40,000
Prepaid expenses: $10,000
These accounts represent resources that the company expects to convert to cash, sell, or consume within the next year or operating cycle. Therefore, they are classified as current assets.
Key Takeaways
- Current assets are resources expected to be converted to cash, sold, or consumed within one year or the operating cycle.
- Common current assets include cash, accounts receivable, inventory, notes receivable, and prepaid expenses.
- Current assets appear before long-term assets on the balance sheet because they are more liquid.
- Analysts often separate current assets into operating current assets and financial current assets for analytical purposes.
- Current assets are an important component of working capital.