Current assets are a category of assets on a company’s balance sheet. They are essential components of a company’s working capital and provide insight into its short-term liquidity and ability to meet its near-term obligations. This blog will discuss current assets, their calculation, types, and other important aspects.
What Are Current Assets?
Definition: Current assets are the liquid assets available to a company at the end of the accounting year. It, therefore, includes cash and those assets and rights of the company that can be converted into cash within the operating cycle.
The operating cycle is the period between purchasing assets and obtaining cash. The duration of this operating cycle is generally one year.
- How to Calculate Current Assets
- Types of Current Assets
- What Elements Make Up Current Assets?
- What Is The Ideal Value For Current Assets?
- Examples of Current Assets
How to Calculate Current Assets
The current assets formula is as follows –
Current Assets = Cash + Cash Equivalents + Inventory + Accounts Receivables + Marketable Securities + Prepaid Expenses + Other Liquid Assets.
Types of Current Assets
Depending on the nature of the asset, there are below types of current assets –
- Inventories: The items for sale in a store are current assets since they are acquired to be sold and not to remain in the company. So are raw materials and products intended to be consumed.
- Cash: The balance of a bank account is current assets since it is immediately available.
- Financial investments: Financial products (funds, deposits) are considered current assets if their maturity is equal to or less than one year. For example, a fixed deposit of three months is a current asset.
- Trade debtors: Invoices pending collection, letters, and promissory notes are current assets since they must be paid quickly.
What Elements Make Up Current Assets?
The main components of the current assets of a company are the following:
- Treasury: It comprises the liquid money in the company’s cash register and different bank accounts (current, savings, etc.).
- Stocks: They are goods intended for sale during the regular course of operation.
- Raw materials: Raw materials are goods intended for transformation and incorporation into the company’s production process.
- Debtors: These are the company’s credits against third parties, including commercial and non-commercial ones.
- Short-term financial investments: They include the financial products available to the company (funds, deposits, etc.), provided that their maturity is equal to or less than one year.
- Negotiable securities: These are included in current assets to be converted into cash within the operating cycle.
What is the Ideal Value for Current Assets?
Ideally, the current assets available to a company should always be more significant than its current liabilities. Otherwise, the company could lack the necessary liquidity to fulfil its corporate purpose and satisfy its short-term debts, which could lead to insolvency.
Therefore, current assets are a fundamental financial indicator of the company’s economic strength since they reflect the payment capacity available to meet its obligations.
Examples of Current Assets
Investments correspond to the company’s securities, shares, and quotas resources. Like CDTs, investments should be classified according to the time required to convert them into cash. Usually, all types of investments are classified as current assets. Except for cases like, for example, shares that some companies acquire intending to keep indefinitely, which leads them to become non-current assets.
Inventories by obligation must be current assets. Since a company cannot afford to buy merchandise to store for months or years, it would incur a high financial cost to have immobilized resources that do not generate any profitability.
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This excludes all merchandise acquired from other suppliers to resell directly later, so it does not require any additional transformation process.
Raw materials correspond to all the products, purchases, or resources available to the company to carry out an industrial transformation process in which it generates its final products.
This category includes merchandise and products used by the company to maintain its operations, among which we can find the following elements: various materials, fuels, materials manufactured by a third party to use in subsequent transformation processes, spare parts, packaging, office supplies, packaging, etc.
These goods are being transformed at the end of the balance sheet but are not semi-finished products or waste.
As its name suggests, these products are manufactured by the company but still need to finish their respective production process, so they can only be sold once they have completed their manufacturing process.
These products have completed their production process and are ready for sale.
By-products, waste, and recovered materials
These products are those to which a particular sale value can be attributed, so they are also usually accounted for even though they already have a reduced sale value.
Treasury and Cash
The treasury is made up of all the liquid money that is at our disposal; that is, it is the cash that we can use immediately, which can be obtained through various instances, such as the following:
- Cash register
- Banks and various credit institutions.
- Short-term, highly liquid investments.
In the case of short-term investments, for them to meet this distinctive characteristic, they must be ordinary in the management of the business and easily accessible. They can be converted to cash in less than three months. And that it is a safe capital or, in other words, does not present risks that could severely modify the amount invested.
This includes all the debts contracted by customers in favour of the company. It includes the debts of the buyers of the goods and services a company offers. As well as commercial credits that are expected to be collected in the short term and are included in subaccounts present in the following cases:
- Client portfolio: This is the amount a company charges through the invoices and manages the collection of goods and services from customers. These charges will be paid when the final payment has been made.
- Factoring operations: Credits assigned through factoring are included here, provided that the company carries out the risks and benefits of the collection procedures.
- Associated companies: Constitutes the debts of those clients that belong to associated companies and groups, which, by belonging to the same product group, are clients of a different type.
They are short-term liquid assets. These include the cash that enters and leaves at all times as part of the productive and commercial activity. This corresponds to the rights and obligations of an economic nature the company can settle in less than one year. The categories of financial accounts are:
- Short-term financial investments in related parties
- Other short-term financial investments
- Other non-bank accounts
Time determines whether or not an asset is a current asset. Companies have different types of assets and rights that are likely to be converted into money. It is a current asset if its capacity to become liquid is effective in fewer than twelve months.
Current assets provide excellent security since, in short, they represent money that a company or an individual can use at any time to resolve a situation or meet a specific payment.
What are some examples of current assets?
Examples of current assets include cash, accounts receivable, inventory, prepaid expenses, and short-term investments.
How are current assets different from fixed assets?
Current assets are short-term resources that facilitate day-to-day operations and are easily convertible to cash, while fixed assets are long-term investments that support a company's core operations and are not typically intended for immediate conversion into cash
What is the significance of current assets for a business?
Current assets provide liquidity and are vital for day-to-day operations, ensuring a company's ability to pay short-term obligations and fund ongoing activities.
How can current assets be managed effectively?
Effective management of current assets involves optimizing inventory levels, monitoring accounts receivable collections, implementing cash flow forecasting, and minimizing idle cash balances.
Can current assets fluctuate over time?
Yes, current assets can fluctuate over time due to factors such as sales and production cycles, changes in customer behavior, economic conditions, and management decisions.