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What is a current asset?

February 23, 2023

When converted into cash, current assets enable you to meet your day-to-day operating expenses, as wells as invoices and loan repayments – also known as current liabilities.As a business owner, you’ll need to complete a balance sheet every year as part of your annual reporting requirements. However, without a financial background, it can be tricky to understand what’s behind the current assets line on a balance sheet.We’ll explain what current assets are, how they’re calculated and why they matter when you’re running your own business.

What is a current asset?

In short, a current asset is an asset expected to be converted into cash in the space of 1 fiscal year.If we consider what a business’s assets are in general, they’re items either owned or controlled for the benefit of the business. This can include company premises, plant and machinery, stock and any cash it owns.Unlike long-term assets, however, current assets are company-owned short-term assets that can be converted to cash by being either sold or used in the space of a year.Non-current, or long-term assets are those that cannot be easily converted into cash within a year. These include fixed assets, long-term tangible assets that are used by a company to generate income and aren’t expected to be used or sold within a year, and intangible assets, such as trademarks, copyrights and intellectual property.Current assets all share the following characteristics:

Are tangible, physical items that are expected to be sold or used within 1 fiscal yearBring financial benefit to a business as enable it to cover day-to-day expenses by being sold or usedAre not subject to depreciation (i.e. not expected to reduce in value over the course of a fiscal year)

Examples of current assets

You may also hear current assets referred to as liquid assets or current account assets as a result of them being held in the short term.Some types of current assets include:

Cash and cash equivalentsInventory and suppliesShort-term investmentsAccounts receivablePrepaid expenses

Cash and cash equivalents

Cash equivalents are the most liquid current assets you can find on a balance sheet, and describe a short-term commitment that can be quickly converted into cash. Examples of cash equivalents include bank certificates of deposit, Treasury bills and banker’s acceptances.

Inventory and supplies

Inventory is used to describe the stock of goods held by a company. These include the products that it expects to sell, as well as raw materials and any other inputs that a company may use in the production of its goods or services.

Short-term investments

Short-term investments describe investments that are expected to mature in a year or less. They are sometimes also referred to as ‘marketable securities’, meaning they can be sold easily to secure funds at short-notice. They include investments such as a higher-yield savings account, short-term bonds and shares.

Accounts receivable

Accounts receivable describes the amount of money due to a company for goods and services that haven’t yet been paid for, and is typically made up by customer invoices and subscriptions.To be classified as a receivable, the counts must be accepted within a year. This means that if you set deferred payment terms or establish a payment to be made in instalments, as long as the amount is paid within the fiscal year, you can include this on your balance sheet.Sometimes there may be doubts that a customer may actually pay their bill in full on time, let alone at all. In these cases, you’d record the receivable as a doubtful account.

Prepaid expenses

Just as money owed to your business counts as a current asset, so do any expenses that a business has paid in advance. These can include prepaid rent and insurance payments.Interest receivable is also a form of current asset.

Why current assets matter in accounting

Current assets can be used to gauge the health of a business as they demonstrate its ability to pay its short-term obligations – namely its bills and loans.The accounting term for this is liquidity, and is commonly expressed as a ratio calculated by comparing a business’ current assets to its current liability.

How to calculate current assets

Once you’ve listed all your current assets on your balance sheet, you can calculate your total net current assets by adding them all together using the following formula:Total Current Assets = Cash + Cash Equivalents + Marketable Securities + Accounts Receivable + Inventory + Supplies + Prepaid Expenses + Other Liquid Assets

Liquidity ratios

You can also use the current assets number on your balance sheet to work out the liquidity ratio for your business. By showing you the balance of assets against liabilities, liquidity ratios are a useful measure of both your company’s financial health, as well as whether it can meet its short-term financial obligations.Some examples of liquidity ratios are explained below:

Current ratio

Your current ratio is the ratio of current assets to current liabilities, showcasing which debts you’ll need to pay off within the year. The formula for your current ratio is super simple, and is as follows:

Quick ratio

The purpose of the quick ratio is to help you understand how well your company can meet its financial obligations by looking at current assets that be converted into cash within 90 days. To calculate this, use the formula:Quick Ratio = (Cash + Cash Equivalents + Marketable Securities + Accounts Receivable)/(Short-term Debt + Accounts Payable + Accrued Liabilities and Other Debts)The higher the quick ratio, the better as it will show that your company has greater liquidity and can generate cash more quickly in the event of an emergency or sudden expense.

Net working capital

You will get a clear view of your company’s short-term financial health, liquidity and know how much money you have right now by calculating net working capital. As well as being a very useful calculation, the formula also easy to remember too: Here at Ember, we know that getting to grips with accounting as a startup isn’t always easy. That’s why our smart features are designed to help streamline your tax and accounting and let you get on with running on your business. You can also access round the clock in-app support from our team of experts for all your accounting queries.