Accounting

Current Assets

By May 7, 2019September 21st, 2021No Comments

What are Current Assets?

Current Assets are cash and other assets that can be converted into cash within one year. For this reason, it’s also known as Short-Term Assets. We’ll use the two terms interchangeably. This is usually the standard definition for Current Assets because most companies have an operating cycle shorter than a year.

However, for companies whose operating cycle is longer than one year, any Asset expected to be converted into cash within the operating cycle can classified as a Current Asset. An operating cycle is the average period of time it takes for the company to produce the goods, sell them, and receive cash from customers.

Generally speaking, most companies have an operating cycle shorter than a year. Therefore, most companies measure their Short-Term Assets based on the criteria of whether they can be liquidated into cash within one year.

Companies disclose the Current Assets they own and their values on the Balance Sheet. The one year period criteria is measured as 12 months from the date of the Balance Sheet.

Current Assets List

Here’s a list of Current Assets that often appear on companies’ Balance Sheets:

  • Cash & Cash Equivalents: Paper bills, coins, bank deposits, money orders, commercial papers, Certificate of Deposits, etc.
  • Short-Term Investments: US Treasuries, stocks, bonds, crypto-currencies, funds, etc. Companies can easily liquidate these investments, often immediately at the click of a button. It’s also known as Marketable Securities.
  • Accounts Receivables: Expected future payment from customers for products already provided. These are payments that customers owe the company for products that they already received. Customers usually pay within 30-90 days. Therefore, Accounts Receivables is a Short-Term Asset.
  • Inventory: Merchandises the company has not yet sold. Inventory is part of the list because most Inventory can be sold within one year.
  • Prepaid Expenses: Value of expenses the company has paid upfront and not yet incurred.
  • Deferred Tax Asset: Asset that allows the company to reduce its future taxable income and pay less taxes.

Different companies will have different lists of Short-Term Assets. Some might have more in addition to the above list. Others might have less. It varies from one company to another because it’s dependent on the business model.

Current Assets Example

Here’s a real Balance Sheet showing the Short-Term Assets of Hershey (NYSE: HSY). You can find the Balance Sheet on PDF page 57 of the company’s annual report.

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The Balance Sheet has three main sections: Assets, Liabilities and Equity. Current Assets is a sub-section within Assets.

The Assets section structures line items by order of liquidity. Liquidity is the ease of conversion into cash. The Assets section orders the most liquid line items first and the lease liquid item last. Therefore, Current Assets are ordered above Non-Current Assets. Within the Current Assets section, nothing is more liquid than Cash & Cash Equivalents. Therefore, Cash & Cash Equivalents is almost always the first line on the Balance Sheet.

Current Assets Formula

To get the most from analyzing Current Assets, you shouldn’t look at them based solely on their absolute values. You should also use Current Assets to calculate various ratios that can yield insights into the operating performance. Here are some formulas that will help you when dealing with Short-Term Assets.

  1. Current Assets = Sum of All Items Listed under Current Assets

    To calculate the total value of Current Assets, we should add up all the items categorized under that section. In the Hershey example, we can just add up Cash & Cash Equivalents, Accounts Receivable, Inventories and Prepaid Expenses. Different companies will have different Short-Term Assets so there isn’t a single formula. Anyone giving you a formula of x+y is ignoring this variability among companies. Therefore, you have to just add up all the items categorized under Current Assets.

  2. Net Working Capital = Current Assets – Current Liabilities

    Net Working Capital (NWC) is the difference between Current Assets and Current Liabilities. You can think of it as the difference between the cash a business will receive and the cash it’ll use in the next 12 months. Whether NWC is positive or negative depends on the business model. Some companies will have positive NWC while others will have consistently negative NWC. Both are normal. What should raise eyebrows, though, is if the business deviates from the historical norm. An example would be a business having negative NWC in one year when it had positive NWC in historical years. So NWC is a metric we need to analyze in relation to a company’s historical performance.

  3. Current Ratio = Current Assets ÷ Current Liabilities

    Current Ratio tells us the percentage of the company’s near-term liabilities that it can repay with liquid assets. The higher the Current Ratio, the safer the company is liquidity-wise. Businesses with high Current Ratio has plenty of cash to cover its operating needs. Companies with Current Ratios <1 could potentially face a liquidity crunch where they don’t have enough cash to fund operations.

  4. Quick Ratio = (Cash & Cash Equivalents + Short-Term Investments + Accounts Receivables) ÷ Current Liabilities

    Quick Ratio is a variation of the Current Ratio, but only based on the most liquid Current Assets. It only includes Cash & Cash Equivalents, Short-Term Investments or Marketable Securities, and Accounts Receivables. Quick Ratio excludes all other Current Assets. This is also a measure of liquidity. A Quick Ratio greater than 1 indicates healthy liquidity.

To learn more about Current Assets, check out our online courses. We’ll go over all the major line items one by one.

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