Understanding Current Assets: Definition, Types and Financial Importance

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Publicly traded corporations are required to publish quarterly balance sheets that allow shareholders to compare a company’s assets with its liabilities. It’s also a good practice for private companies to create balance sheets to stay organized. These balance sheets contain several items, including current assets.

Current assets reflect a company’s short-term assets that can be converted into cash within one year. Investors and leaders within the company can compare current assets with current liabilities to determine if the firm can stay on top of its financial obligations. This guide will break down the different types of current assets, why they matter and important calculations you can use to determine the financial strength of any company.

Types of Current Assets

Current assets are one of the first items that appear on a balance sheet. This section contains each individual current asset and then their total. These are some of the most common current assets that you will find on any balance sheet.

Cash and Cash Equivalents

These current assets are already liquid cash, making them immediately available if a company needs to cover a short-term liability. Certificates of deposit, money markets and short-term bonds count as cash equivalents.

Accounts Receivable

These current assets represent revenue that a company is supposed to realize within one year. Some customers buy products and services before fully paying for them. The remaining payments are in accounts receivable until the customer pays for them.

Inventory

Inventory reflects a company’s unsold products that are expected to be sold within one year. For instance, Apple includes unsold iPhones in its inventory since it’s expected to sell those iPhones within the same year.

Most inventory loses value if it remains unsold, which creates some uncertainty around this metric. However, companies can look at previous sales trends to gauge how much inventory they can sell in a given year.

Marketable Securities

Marketable securities include liquid assets that can easily be converted into cash. Each time a corporation initiates a stock buyback, it increases its marketable securities. These securities can gain value, and a company is not obligated to sell its shares. Only unrestricted shares count as current assets.

Prepaid Expenses

Prepaid expenses consist of liabilities that were paid for in advance. For instance, a company that uses an annual payment plan for software has a prepaid expense for the year. That’s because the business will continue to use this prepaid software for the next 12 months.

Prepaid expenses are the only current assets that cannot be immediately converted into cash. However, a prepaid expense will decrease your current liabilities.

Current Assets Formula and Calculation

The current asset formula includes the total sum of all current assets. Businesses can use this formula to assess their ability to cover current liabilities and remain financially solvent if revenue slows down.

Here’s the formula:

Current assets = cash and cash equivalents + accounts receivable + inventory + other current assets

Current assets should exceed current liabilities. Companies with wider gaps among these metrics are in better financial positions. Businesses with higher current liabilities than current assets may be forced to take on more debt or sell long-term assets to keep up with current obligations. This setup can make it challenging for a business to remain solvent.

The Importance of Current Assets in Financial Planning

Current assets allow companies and investors to assess if a firm can pay off its financial obligations. Companies that cannot keep up with short-term liabilities may stagnate, lose market share or become insolvent in the long run.

Business owners can review their current assets to determine how many liabilities they can incur. It’s similar to knowing your monthly income and using that number to gauge how much credit card debt you can safely accumulate each month. Earning $5,000 per month and spending $6,000 per month will eventually catch up with anyone.

Tracking current assets and comparing them to current liabilities helps business owners stay on top of their expenses. It also helps investors pinpoint promising long-term opportunities.

Current Assets vs. Fixed Assets

Some assets are easier to convert into cash than others, and that’s the key distinction between current assets and fixed assets. While current assets can be converted into cash within one year, it can take several years to turn fixed assets into cash. For instance, it can take Chipotle multiple years to sell one of its properties if it decides to exit an area. Fixed assets like properties and equipment aren’t going to cover current liabilities. However, fixed assets are vital parts of the company that enable current assets to grow.

Examples of Current Assets in Action

You can look at any corporation’s balance sheet to see its current assets. In the second quarter of 2024, Amazon reported $173.3 billion in total current assets. Cash and cash equivalents made up most of the company’s current assets, but they also included marketable securities, inventories and accounts receivable as balance sheet items. The tech giant also had $158.2 billion in current liabilities, demonstrating that the company can keep up with its financial obligations.

Alphabet also reported a pristine balance sheet in Q2 2024. The tech giant’s current assets came to $162.0 billion while current liabilities were $77.9 billion. The wide gap between current assets and current liabilities suggests strong cash flow, which has helped support Alphabet’s recent dividend program. It’s also important to note that Alphabet doesn’t list inventory on its balance sheet. That means little to none of the company’s current assets are tied to unsold products.

The Role of Current Assets in Personal Finance

Current assets aren’t only useful for corporations. Individuals who know their current assets can fortify their finances and put themselves in a better position to cover financial obligations. Your current assets include your checking accounts, savings accounts, liquid investments and prepaid expenses.

Knowing your current assets can help you gauge how much liabilities you can incur. You can also decide which current assets are off-limits, such as your liquid investments. Keeping your current assets in mind can lead to more conscious spending habits that reduce your credit card debt. Individuals can also calculate how their current assets are able to address current liabilities, such as monthly mortgage and auto loan payments.

Current Assets in Financial Ratios

Investors and business owners use financial ratios to assess a company’s financial health and long-term prospects. While you can easily run a Google search and find a stock’s P/E ratio and market price, it takes a little more digging to use financial ratios like the current and quick ratios.

The current ratio divides current assets by current liabilities. For instance, Alphabet’s Q2 2024 balance sheet had $162.0 billion in current assets compared to $77.9 billion in current liabilities.

Here’s how you would calculate Alphabet’s current ratio:

• Current ratio = current assets / current liabilities
• Current ratio = $162.0 billion / $77.9 billion
• Current ratio = 2.08

A current ratio above 1.0 indicates that a company can keep up with its current liabilities. While a good current ratio depends on the industry due to varying profit margins and expectations, a current ratio from 1.5 to 2.5 tends to indicate a promising company. Alphabet has an exceptional current ratio that demonstrates a strong financial position. A high current ratio is part of the reason Alphabet stock has gained more than 150% over the past five years.

The quick ratio is just like the current ratio, except for a small difference. Inventory is deducted from current assets. Then, you have to divide that sum by current liabilities.

The formula looks like this:

• Quick ratio = (current assets – inventory) / current liabilities

Amazon’s Q2 2024 balance sheet, featured $173.3 billion in current assets and $158.2 billion in current liabilities. That translates into a decent 1.10 current ratio. However, Amazon reported $34.1 billion in inventory on its Q2 2024 balance sheet. Despite having a decent current ratio, Amazon has a quick ratio below 1.0.

• Quick ratio = ($173.3 billion – $34.1 billion) / $158.2 billion
• Quick ratio = $139.2 billion / $158.2 billion
• Quick ratio = 0.88

The quick ratio indicates that Amazon depends on inventory sales to keep up with current liabilities. Amazon may have to borrow money or sell some of its long-term assets to address current liabilities if the business experiences a slowdown. While Amazon is unlikely to experience a slowdown, it’s good to know how a sudden drop in inventory sales can impact any company’s finances.

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