Current Assets Formula
The key part here is the “long-term debt” part of the equation. Long-term debt refers to any liability that has a measurable maturity date.
The other two parts of the equation are relatively easy to understand. Current assets are cash and other items that can be converted into cash quickly. Current liabilities are the debts that need to be settled in the near term, or within one year.
This part of the equation is the key to understanding current assets. If you have assets that are considered long term, but short-term current liabilities, your company will have nothing when it comes time to pay its debts. The current assets equation also explains the organization’s ability to carry on its normal operations.
It’s not only important for a company to maintain a healthy cash balance, but also its ability to make loans and investments.
Cash & Cash Equivalents
The term “current assets” usually refers to the assets that a company needs to support its current business operations … the company’s short-term financial liabilities. Cash, accounts receivable, inventory, prepaid expenses, and other assets that are expected to be converted into cash and sold within one year are considered current assets. Cash … the most commonly used term to refer to cash or cash equivalents such as bank accounts, vault cash, or money market instruments … is also considered a current asset because it is generally considered to be an asset that a company can convert into cash within a year.
Some companies are able to raise money through short-term loans, such as credit card loans, lines of credit, and other short-term loans. Loans that a company takes out that are likely to be repaid within 12 months or less are considered current liabilities. In the case of accounts receivable, which are considered current assets for a company, this includes accounts receivable that the company is able to expect to convert into cash within a year.
Current assets are generally listed on a company’s balance sheet. Current liabilities, on the other hand, are usually listed on the liabilities section of a company’s balance sheet.
Any money received from customers for products or services that have been provided but not yet paid for.
Inventory – All items that have been purchased, produced, stockpiled, and awaiting sale… including raw materials, work in process, finished goods and supplies.
Loans payable – Money owed to you from another person or owed to a bank by another person such as a mortgage, car payments, and credit card debt.
Property, Plant, and Equipment – A significant item of an organization that is used in its operations and would be difficult to replace if lost or stolen. When you buy a computer or a truck, you are buying a piece of property, plant, and equipment.
Receivables – The amount of money you have sitting on the table waiting to be picked up by a customer.
Capital Assets – Anything you purchase with the intention of holding onto for a longer time period such as equipment, machinery, and buildings.
Marketable securities refer to the securities that are sold, traded or that can easily be converted to cash.
There are a number of types of marketable securities. Some of the more common types of marketable securities are stocks, bonds, government securities, commercial paper and certificates of deposit.
The balance sheet reflects the difference between the cost basis and the market value of marketable securities at a given date. Current assets are those assets which can be sold in the short term to meet current liabilities or quickly converted to cash.
Project-finance costs and prepaid expenses are recorded as current assets on the balance sheet. The most common prepaid expense is depreciation. Usually it costs more to build an asset the first time than it does to build it the second time, so a portion of the cost is expensed or prepaid the year the first asset is built. For example, imagine you are building a nitrogen production plant for the first time. Financing costs are deducted from the cost of the asset. The cash paid for the asset is the total cost.
But because the asset will produce nitrogen for the next 20 years, a portion of the cost is expensed. On the balance sheet, this expense is recorded as current assets – prepaid expenses. This portion of the expense is called depreciation expense. The income statement reports the cost of the asset, showing the cash paid for the asset. There will also be another entry for depreciation expense. The difference between the income statement and the balance sheet is called equity.
Other Liquid Assets
Like current assets, other liquid assets also can be broken down into two sets: cash on hand or cash equivalents and short term investments. Cash on hand refers to any cash that is currently held. While short term investments are for any type of asset that is not intended for use in the immediate future but will be used in the future. Other liquid assets are generally short-term in nature and they are used to either replace cash flow or supplement cash flow. Other liquid assets are for a range of types of investments that can be customized to fit any type of possible cash flow. An example is selling stock to meet a debt obligation. Or if there is a cash flow shortage, the emergency cash can be drawn from the short term investments.
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Current Assets Example
Current assets are assets which are able to be converted into cash within a year. They are a part of the balance sheet and they include inventory, receivables and prepaid expenses.
A current asset can be any asset whose value can be quickly converted into cash. These are normally items which are bought to sell or items which can be used as collateral. The key feature of the asset is that they generate income and/or are used as a security.
Video Source: How To Calculate Current Assets.
Often, current assets are lumped with working capital in the balance sheet, but there are some differences. Working capital is similar in the sense that it is represented by inventory and receivables. However, working capital isn’t as liquid as the current assets, so it is more restricted.
A current asset is a part of the balance sheet and it involves items which are bought to sell them at a later date. This is why many businesses will also have working capital. However, this type of investment is held only temporarily and is bought on the basis of it generating income or being used as a security. .
Here we lay down the formula for tracking current assets.
Total Current Assets = Current Assets (a) + Current Liabilities (B)
The total current assets are the current assets plus the current liabilities.
Why are Current Assets Important?
Current assets are assets that are acquired within a given accounting period and which currently generate cash flows. These asset classes are generated by the financial activity of the company.
Current assets include cash and cash equivalents as well as receivables and inventory. In most cases, current assets are highly liquid and have a high liquidity.
In a continuous flow-accounting context, current assets are equal to current liabilities. This is because current assets are the assets on which the company has an obligation to honor a liability.
Current assets are important because a number of current assets are required to use a company’s assets over the long term. What’s more, current assets are used to calculate the current ratio.
Current assets are the only assets which are taken into account in determining solvency. Because of this, these assets should be prudently managed at all times.