General Concepts of Current Assets
Current Assets (CA) is very important items for the management in the daily operation of the business. This is the items which refer all the items that could be conveniently sold, consumed, utilized or exhausted through the normal business operations. This kind of assets helps to generate cash within the year. Currents Assets includes Cash and Cash Equivalents, Accounts receivable, Inventory, Marketable Securities, Pre-Payments and other liquid assets of the company.
Current Assets also consider as liquid assets because this kind of assets can be converted easily into cash in a short time period of time. For Example – Inventory. Inventory can be sold easily for cash within 12 months. Company’s management, as well as Other stakeholders like investors, creditors, lenders etc, are seriously considering this component to confirm whether they can get their invested money.
Key Components of Current Assets
The key components of Currents assets are as follows:
- Cash & Cash Equivalents
- Accounts Receivable
- Prepaid Expenses
- Note Receivable
- Deferred Income taxes
Cash and Cash Equivalents:
Cash represents all kinds of hard cash i.e coin and currency that a company owns. This includes Cash at Bank, Petty cash balance, and other deposits.
Cash Equivalents are an investment that is closely related to cash and can be converted into cash easily. Treasury Bill, T-Bill is the simple example of this because these can be exchanged for cash at any point without any risk.
This can be compared to short-term loan to the customer. This is the case where goods are sold on credit to the customer. usually, customers can purchase goods and pay for them in 30 to 90 days. Bad debt will be subtracted from the total receivable account and to be transferred to Profit and Loss Account.
This is the merchandise that a company buys to sell its customer for a profit by changing the shape or without changing. Raw Materials, Finished goods, Work in Progress etc the common example of inventory.
Prepaid expenses paid before the transactions are made. Insurance is a good example of prepaid expenses.
Investments are short-term in nature and expected to be sold in the current period. Investments in stock are one of a good example.
This is a written promise to receive a specific amount of cash from another party on future dates. These notes mature within a year or the current period.
Deferred Income Taxes:
When a company overpaid taxes than its normal calculation is called deferred taxes. This tax can be refunded or to adjusted with future tax.
Current Assets Formula
Current Assets calculations are easier one. The important matter is all assets classifies as current assets are included in current assets formula.
Formula of Currents Assets:
Current Assets = Cash & Cash Equivalents + Accounts Receivable + Inventory + Marketable Securities + Prepaid Expenses + Other liquid assets.
Calculation of Average Current Assets
Average Current Assets of the company is the average value of a company’s short-term assets from one period to another. Average currents assets are usually calculated as average annual assets, Average assets help to understand to the management of the company regarding average monthly short-term assets which would help to manage, plan, and budget for the future.
For example, to calculate average total assets for the year, add the total current assets from the end of the previous year to the total short-term assets from the end of the present year, and then divide by two.
The formula for the average current assets is as follows:
Average Current Assets =
(Total current assets for previous period + Total current assets for current period) / 2
For example, if on Dec 31st, 2017, your current assets are $125,000, and then on Dec 31st, 2018, your current assets are $373,000, What will be your Average current Assets?
($125,000 + $373,000) / 2 = $249,000
Importance of Current Assets
Current assets are very important elements for the management of the company. It helps to conduct the smooth daily operation of the business. Payable to creditors, repayment of loan installment, wages payment are the frequent payment of the company. If the company suffers cash liquidity, it will hamper all of the necessary payment. Consequently, Supplier may stop to deliver the necessary supply for the production, failure to pay loan installment may make the company bankrupt and workers may be left if wages do not pay at timely. Hence, Currents Assets plays a significant role in the company.
Common Ratios using in Current Assets
The Current Ratio:
Current Ratio measures the ability of the company to pay short term and long term obligations and takes into account the current assets of a company relative to the current liabilities.
The Quick Ratio:
This ratio helps to measure the ability of the company to meet its short-term obligations with its liquid assets. It considers Cash and Cash Equivalents, Marketable Securities and Accounts Receivable against the current liabilities. Inventory will be excluded from this computation.
The Cash Ratio:
This ratio measures the ability of a company to pay off all its short-term liabilities immediately and is calculated by dividing the cash and cash equivalents by current liabilities.