Current asset definition
/What is a Current Asset?
A current asset is an item on an entity's balance sheet that is either cash, a cash equivalent, or which can be converted into cash within one year. If an organization has an operating cycle lasting more than one year, an asset is still classified as current as long as it is converted into cash within the operating cycle.
Current Asset Presentation in the Balance Sheet
Current assets appear at the top of the balance sheet, before any non-current assets. A sample presentation of current assets is highlighted in the following balance sheet exhibit.
Types of Current Assets
There are many types of current assets, which vary by industry. Generally, the following asset types are classified as current assets within most industries:
Cash and cash equivalents. This includes physical currency, checking accounts, and short-term investments that are easily converted to cash, such as Treasury bills or money market funds. These assets are the most liquid and are used to meet immediate financial obligations.
Marketable securities. These are short-term investments in stocks, bonds, or other financial instruments that can be quickly sold for cash. They are considered liquid and are often used to earn a return on excess cash reserves.
Accounts receivable. Accounts receivable represent amounts owed to the business by customers for goods or services delivered on credit. They are typically expected to be collected within 30 to 90 days, making them a key component of working capital.
Prepaid expenses. Prepaid expenses are payments made in advance for goods or services to be received in the future, such as rent or insurance. These are recorded as assets because they provide future economic benefits.
Short-term notes receivable. These are written promises from customers or other parties to pay a specific amount within a short time frame, usually less than a year. They generate interest income and are considered more formal than accounts receivable.
Inventory. Inventory includes raw materials, work-in-process, and finished goods held for sale. It is a current asset because it is expected to be sold and converted into cash within the business’s operating cycle.
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The Order of Liquidity
These items are typically presented in the balance sheet in their order of liquidity, which means that the most liquid items are shown first. The preceding example shows current assets in their order of liquidity. After current assets, the balance sheet lists long-term assets, which include fixed tangible and intangible assets.
How Current Assets Information is Used
Creditors are interested in the proportion of current assets to current liabilities, since it indicates the short-term liquidity of an entity. In essence, having substantially more current assets than liabilities indicates that a business should be able to meet its short-term obligations. This type of liquidity-related analysis can involve the use of several ratios, include the cash ratio, current ratio, and quick ratio.
The main problem with relying upon current assets as a measure of liquidity is that some of the accounts within this classification are not so liquid. In particular, it may be difficult to readily convert inventory into cash. Similarly, there may be some extremely overdue invoices within the accounts receivable number, though there should be an offsetting amount in the allowance for doubtful accounts to represent the amount that is not expected to be collected. Thus, the contents of current assets should be closely examined to ascertain the true liquidity of a business.
Terms Similar to Current Asset
Current assets are also known as current accounts.