Understanding the basics of finance is not particularly difficult; you just have to know the lingo. Many easy concepts are disguised by words specific to the field and “current assets” is a prime example of this. Assets are really just positive value items in a company’s possession (liabilities are the negative value items).
But current assets, as the name implies, are important in a company’s right now; it other words, they are fairly active. Below we’ll hash out a more in-depth definition and understanding of current assets and provide a list of common examples. Learn everything an entrepreneur needs to know about the world of finance with this lean finance course for startups.
What Are Current Assets?
When it comes to discussing assets, the “one year” time frame is the great divider. Current assets are those assets that a company predicts it will use (or convert to cash or investment capital) within one year’s time of those assets appearing on the balance sheet. The assumption is that they will be used considering “normal” circumstances.
While this article is primarily concerned with current assets as they apply to business, in personal financing current assets are those that can be quickly converted to cash, i.e. highly liquid.
In case you were wondering, non-current assets (which are real) are those assets that the company predicts it will hold for at least a year. It’s as simple as that. Check out this blog post on financial accounting for a few easy concepts that everyone should know.
Why Does The Distinction Matter?
Why distinguish between current and non-current assets? As you might have guessed, current assets are so vital because they offer a realistic view of how much capital a company can, and likely will, access within the next 12 months. Current assets do not include things like fund raising or other third-party options; they are strictly within the company’s own infrastructure.
Furthermore, current assets are kind of like the blood pressure of money flow; they represent a realistic view of how the company is going to operate on a daily basis and, ultimately, the company’s liquidity (where it is always good to know where you stand).
Examples Of Current Assets
The most common examples of current assets are cash, accounts receivable, prepaid expenses and inventory.
Companies like cash (obviously) because it’s the most efficient way to pay for liabilities. Ideally, a company’s cash account always has money in it; it acts as a reserve, in some ways, that often be drawn on monthly to pay utility bills and other relatively manageable expenses. Cash is the most current of current assets.
Current cash assets include checks not yet deposited, physical/petty cash (which is generally a very small amount) and cash in banks. You might also consider cash-equivalents as cash (short-term securities, etc.). This introduction to bookkeeping course can teach you how to enter and manage all of your finances.
- Accounts Receivable
These accounts amount to all the money owed to the business by its clients and customers. In other words, they are closed sales. There are millions of examples of how businesses receive cash on a delayed structure.
Let’s look at health care, for example. When someone goes to the dentist – assuming they have dental insurance, but even if they don’t – they do not typically pay on the same day as their appointment. In the case of the insured patient, the dental office will charge the insurance company what it can and then send the remaining bill to the patient. Now the dental office has an account receivable from the insurance company (they must pay a portion of the bill) as well as from the patient (they must pay the remainder of the bill). Usually there will be a 30 day window in which payment can be made, so clearly this is a current asset.
- Prepaid Expenses
Prepaid expenses are slightly more difficult to understand. How can spent money be an asset?
The best example is the one in which bills are paid far in advance. Let’s say a horse farm needs a monthly shipment of alfalfa. If they know how much alfalfa they will need, and if they can obtain a discounted price by paying in advance, then they might opt to pay for six or even twelve months of alfalfa in advance. These prepaid expenses qualify as current assets.
These assets will never turn into cash, so how are they current? Believe it or not, it takes a little imagination. Imagine that when every month rolls around (having already paid for six or twelve months), that the money “comes back” to the company. It is almost like an account receivable for itself. Every month the company does not need to pay is a form of that asset being activated in a current sense.
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While inventory is easier to understand, it isn’t as cut-and-dry and as you might think. Obviously, any products available and expected to be sold within one year are current assets. But inventory includes both completed products as well as materials to make the products. Now we have to categorize our inventory.
We’ll take our products available for sale for granted and just call those “finished products.” Our second type of inventory is raw material. This can be anything from a pile of lumber waiting to be milled to a box of nails that will be used on the finished wood. Raw materials are purchased items that are not yet sellable.
Finally we have our work-in-progress (WIP) inventory. This is the middle ground between raw materials and finished products. A car on the assembly line would be a WIP, as would a partially constructed piece of furniture (wood, nails, etc.).
If you found this article illuminating (even mildly so), then you should consider broadening your knowledge of finances; it’s just good to know, whether you’re in business or not. Here’s a five-star introductory course to finance and accounting to get you started.