Current Assets

In financial terms, an asset is any valuable resource that a business owns. Anything tangible or intangible that a company possesses to create an economic value can be considered as an asset.

An asset gets classified into three types based on convertibility, physical assets, and resources. Based on convertibility, the asset gets further sub-divided into current and non-current assets. In finance, an asset can be defined as a valuable resource that a business owns. A tangible or intangible resource that a company owns to create values in the economy is called an asset. They are divided into 3 types which are based on the factors like physical assets, resources and convertibility. Based on convertibility, the assets are again divided into current and noncurrent assets. Here, we will learn about current assets. They are the resources that are possessed by a company and can be converted into cash during the financial years. They are sold and consumed due to the business operations that occur. This may include cash or cash equivalents which are expected to be converted during an operating cycle.  They appear as the standard item under the section of assets in the firm’s balance sheet and play an important role in the assessment of the ratio and management of working capital. The components of the current assets are cash and cash equivalents, receivable account, inventory and prepaid expenses. Cash and cash equivalents are the properties that can be liquidated and they are the values of the company’s properties. These include commercial papers, bank accounts and debt securities etc.

For example, a company XYZ will have total current assets that are cash, inventory and receivable accounts. The current asset amounts vary for different firms or companies.

Definition of Current Assets

Current assets are those resources which a company owns and expects to convert into cash during a financial year. These get sold, exhausted or consumed due to the ordinary course of operations of the business. 

According to the current assets definition, they include cash or cash equivalents that a business expects to be converted during one operating cycle.

These appear as a standard item under the assets section in the balance sheet of the firm. They are a vital component in the assessment of working capital management and the current ratio. 

According to the current asset examples, a leading e-commerce company X total current assets for the financial year 2019 comprises cash (Rs. 10,00,000), inventory (Rs. 20,00,000), account receivables (Rs. 7,00,000), etc.

Similarly, another leading manufacturer XYZ has a total summation of cash (Rs. 13,00,000), pre-paid expenses (Rs. 5,00,000), inventory (Rs. 25,00,000). The total current assets of the company account for Rs. 43,00,000.

What are Non-Current Assets?

Non-currents assets are long term investments that cannot be easily converted into cash or cash equivalents. The entire value of these assets cannot be utilised during a fiscal year. As a result, these are also known as fixed assets.

For example – A company ABC has a total non-current assets of Rs.1,40,00,000. It is the summation of land (Rs. 60,00,000), buildings (Rs. 50,00,000), and machinery (Rs. 30,00,000), etc. 

Land, buildings, patent, trademarks, equipment and machinery are a few other examples of fixed assets.

What are the Components of Current Assets?

These assets consist of various components that ascertain the worth of the firm. For example –

• Cash and Cash Equivalents – These are those items in the balance sheet that can be liquidated immediately. They account for the value of the company’s assets, and these include bank accounts, commercial papers, treasury bills and debt securities that contain a maturity date of three months or less.

• Account Receivables – These constitute the money that a firm owes from its customers for the goods and services delivered. The business expects to receive these amounts within one operational year. However, many times a business fails to recover its entire amount from the customers. These get listed under bad debts of the company, and they do not come under the current assets.

• Inventory – The stocks include raw materials and finished products which a firm calculates in the assets segment. However, there are other accounting methods that a business adopts to ascertain the inventory, such as LIFO (last-in, first-out) and FIFO (first-in, first-out).   

• Pre-paid Expenses – These include the costs that a company pays in advance to receive the goods and services in future. A business cannot convert such current assets into cash. The future expenses comprise the insurance premium that a firm incurs in a financial year.

The Formula of the Current Assets

The asset side of the balance sheet comprises cash and equivalents (including petty cash, currency, etc.), account payables, prepaid expenses, etc. A business ascertains its profit or loss by tallying both the assets and the liabilities. 

The assets are arranged in reverse chronological order of liquidity in the balance sheet. The items having higher chances of cash conversion are placed first and vice versa. 

One can determine current assets by merely summing up all the assets that have chances of conversion within an operational year. The current assets formula can be shown below as:

Current Assets = Cash and Cash Equivalents + Accounts Receivables + Marketable Securities + Inventory + Prepaid expenses + Other Liquid Assets

A firm uses current assets in many formulas to ascertain the costs and profits that occurred in the fiscal year. Some of the formulas are as follows:

1. Current ratio

2. Average current assets

3. Quick ratio

4. Net working capital

What is the Current Ratio and How to calculate it?

It is used to calculate the capacity of a business to meet its short-term obligations. A firm ascertains it to understand its liquidity. The current ratio varies from one organisation to the other.

The formula to calculate it is listed underneath as:

Current Ratio = Current Assets/ Current Liabilities, 

Current liabilities are the items that the company owes to its customers. These include accounts payable, bank overdrafts, accrued expenses, etc.

How are the Quick Ratio and Net Working Capital formulated?

A firm uses current assets to measure the quick ratio or liquidity ratio of the firm. The ratio is also known as the acid-test ratio, and one can obtain it by dividing quick assets by current liabilities. However, it can also be calculated by subtracting current assets from inventory and prepaid expenses, divided by current liabilities. 

Quick ratio = Quick assets (Cash + Account Receivables + Marketable Securities)/ Current Liabilities

Or, 

Quick Ratio = (Current Assets – Prepaid Expenses - Inventory)/ Current Liabilities  

One can use networking capital to understand the earning cycle. One can calculate it as follow:

Net Working Capital = Current Assets – Current Liabilities

How to Ascertain Average Current Assets?

One can calculate average current assets by dividing both the total assets of the present year plus the preceding year by the number of years.

Average Current Assets =\[\frac{(Assets \, of \, the \, present \, year + Assets \, of \, the \, preceding \, year)}{2}\]

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