Question

Define 'current assets' and give four examples.

Answer 1

A current asset, also called a current account, is either cash or a resource that are expected to be converted into cash within one year.

These resources are often referred to as liquid assets because they are so easily converted into cash in a short period of time. Take inventory for example. Inventory can easily be sold for cash in the next 12 months. Contrast that with a piece of equipment that is much more difficult to sell. Also, inventory is expected to be sold in the normal course of business for retailers. Equipment, on the other hand, are not.

This concept is extremely important to management in the daily operations of a business. As monthly bills and loans become due, management must convert enough current resources into cash to pay its obligations.

Cash – Cash is all coin and currency a company owns. This includes all of the money in a company’s bank account, cash registers, petty cash drawer, and any other depository. This can include domestic or foreign currencies, but investments are not included.

Cash Equivalents – Cash equivalents are investments that are so closely related to cash and so easily converted into cash, they might as well be currency. An example of an equivalent is a US Treasury Bill. T-bills can be exchanged for cash at any point with no risk of losing their value.

Accounts Receivable – Accounts receivable is essentially a short-term loan to customers and vendors who purchase goods on account. Typically, customers can purchase goods and pay for them in 30 to 90 days. Accounts receivable keeps track of these loans.

Inventory – Inventory is the merchandise that a company purchases or makes to sell to customers for a profit. This could be anything from pencils to cars to houses. It depends on the business. For example, a car dealership is in the business of reselling cars. Thus, their cars are considered inventory, even though they have plenty of pencils in their offices.

Prepaid Expenses – Prepaid expenses are exactly what they sound like—expenses that have been paid before they were consumed. Insurance is a good example. A six-month insurance policy is usually paid for up front even though the insurance isn’t used for another six months. Even though these assets will not actually be converted into cash, they will be consumed in the current period.

Investments – Investments that are short-term in nature and expected to be sold in the current period are also included in this category. These typically include investments in stock called available for sale securities.

Notes Receivable – Notes that mature within a year or the current period are often grouped in the current assets section of the balance sheet.