Current Assets in Accounting. Examples and detailed view

Current Assets

To properly understand and manage your finances, it is essential to have a strong understanding of accounting principles. In this blog post, we will be discussing current assets in accounting. This includes what they are and how they are classified on balance sheets. By the end of this post, you will better understand how to account for them on your balance sheet. 

A company's balance sheet shows an organization's financial position at a specific time. They are listed as a subcategory of assets on a company's balance sheet. They are reported as the value of cash, inventory, and other assets that can be converted to cash or spent within one year. There are several types of current assets, such as cash, accounts receivable, inventory, and prepaid expenses.

Each type has its role in accounting. These examples will help you understand how they are impact your company's financial statements.

Types of Current Assets

• Cash is one of the essential current assets for any business. It includes money in the bank, cash on hand, and other liquid assets. Cash is the foundation of any business and is necessary for short-term operations and to pay off liabilities.
  
  Marketable securities are investments that can be quickly sold for cash. These include stocks, bonds, and mutual funds. Marketable securities are a great way to generate cash quickly and are often used to finance short-term operations.
  
  Accounts receivable is any money that customers owe to the business. This money is due within a year and can be quickly collected as cash. Accounts receivable is an essential source of cash and is often used to finance operations.
  
  Inventory is a collection of goods that a business has for sale. This includes raw materials, finished goods, and other items the business has in stock. Inventory is an essential source of cash and is often used to finance the production of goods.
  
  Prepaid expenses are any costs that have been paid in advance. These include insurance premiums, rent, and other costs paid ahead of time. Prepaid expenses are an essential source of cash and can be used to finance operations.

What Are the Benefits of Current Assets?

Liquidity and Financial Stability

• Immediate Cash Flow: Current assets ensure a company has enough liquidity to meet its short-term obligations, such as paying suppliers, employees, and other operational expenses. This immediate availability of cash or near-cash assets prevents disruptions in operations and contributes to financial stability.
• Cushion Against Uncertainty: Having ample current assets is a buffer against unexpected financial challenges or economic downturns, allowing the company to navigate tough times without severe strain.

Operational Efficiency

• Smooth Operations: Adequate current assets, particularly cash and inventory, ensure that the production and sales processes run smoothly without interruptions caused by a lack of resources.
• Customer Satisfaction: Maintaining optimal inventory levels helps meet customer demands promptly, enhancing customer satisfaction and loyalty.

Flexibility and Growth Opportunities

• Investment and Expansion: With sufficient current assets, a company can quickly seize new business opportunities, invest in new projects, or expand its operations without securing external financing.
• Negotiation Power: Companies with solid liquidity can negotiate better terms with suppliers and creditors, potentially securing discounts or more favourable credit terms.

Creditworthiness and Financial Health

• Improved Credit Ratings: A robust balance of current assets improves a company’s creditworthiness, making obtaining loans or credit facilities easier at favourable terms.
• Investor Confidence: Investors view companies with healthy current assets favourably, as it indicates good financial health and risk management, which can lead to higher stock prices and easier access to capital markets.

Risk Management

• Reduced Bankruptcy Risk: By ensuring that current assets cover current liabilities, companies reduce the risk of insolvency and bankruptcy, thereby securing long-term sustainability.
• Diversification of Risk: A mix of different types of current assets (cash, receivables, and inventory) diversifies risk, as a decline in one asset class can be offset by stability or gains in another.

Performance Measurement

• Financial Ratios: Current assets are crucial in calculating key financial ratios, such as the current ratio and quick ratio, which help assess the company’s short-term financial health and operational efficiency.
• Benchmarking: These ratios provide benchmarks for management to monitor performance over time and make informed strategic decisions.

What Are the Risks of Having Too Many Current Assets?

It is important to remember that while current assets are essential and can generate cash, they can also carry risks. The most common risk is that the value  can fluctuate quickly. This can lead to losses in value if you are not careful.

Another risk is that too much money may be tied up. This could prevent the business from investing in new products or services that may be more profitable. Finally, there is the risk that these assets may not generate enough cash to cover current liabilities.

Accounting

It is crucial to accurately record all of your current assets so that you can track their value and performance over time. This will help you identify areas where you may be over or under-invested and make any necessary adjustments.

To accurately record them, you need to calculate the value of each asset and record it in the appropriate accounts. This includes cash, marketable securities, accounts receivable, inventory, and prepaid expenses.

Best Practices for Accounting with Current Assets

There are a few best practices for accounting with current assets.

• First, it is essential to track and record them accurately. This will help you identify areas where you may be over or under-invested and make any necessary adjustments.
• Second, it is essential to diversify your current assets. This will help to protect you from any sudden losses in value and ensure that you have a steady source of cash.
• Third, it is essential to review them  periodically. This will help identify areas where you may be over-invested or under-invested and allow you to make any necessary adjustments.
• Finally, it is essential to reinvest any profits from these assets back into the business. This will help ensure that you continually grow and generate more cash.

What are cash and cash equivalents on a balance sheet?

Cash equivalents are readily convertible into cash. The main difference is that cash equivalents are invested in lower-risk assets, such as government bonds and treasury bills. 

Cash equivalents are listed on the balance sheet as a current asset. It can also earn interest or have already been converted to cash. Cash equivalents include short-term government bonds and treasury bills. They earn interest, but investors can sell them for cash anytime.

As per IFRS or USGAAP, any assets easily liquidated within three months are classified under cash and cash equivalents.

How do current and fixed assets differ?

Current assets are assets that can be converted to cash within a year. They are usually listed as a subcategory of assets on the balance sheet. Fixed assets cannot be converted to cash or sold within a year. The cost of these assets is amortized over several years. 

How Do Investors Use Current Assets?

When analyzing the health of a company, investors often look at the ratio of current assets to current liabilities. This ratio is often referred to as the working capital ratio and is used to determine how easily a company can meet their short-term financial obligations. 

To understand how this ratio is calculated, you'll need to understand the difference between current assets and liabilities. 

Current liabilities are short-term debts, accruals and financial obligations that must be paid within one year. Current assets include cash and other assets that can be quickly converted to cash in an emergency. 

Companies can use these current assets to meet their short-term debt obligations. Current liabilities are costs that must be paid within one year, such as credit card bills and short-term loans. If a company's current assets are more significant than its current liabilities, it may be able to meet any unexpected financial obligations without having to borrow money.

What are the Financial Ratios That Use Current Assets

Two financial ratios use current assets. 

• the current ratio, and 
• the acid-test ratio. 

The current ratio measures a company's ability to pay its current liabilities. The current ratio is calculated by dividing current assets by current liabilities. 

The acid-test ratio is a more narrow version of the current ratio. The acid-test ratio only considers cash and marketable securities as current assets. Current liabilities are calculated the same way as in the current ratio.

Academic research articles on "Current Assets" in IFRS:

1. Comparative Analysis of Current Ratio, Debt to Assets Ratio, Debt to Equity Ratio, Net Profit Margin, and Return on Assets Before and After IFRS Convergence
   • This research empirically tests the comparison of financial performance before and after the convergence of IFRS using various financial ratios, including the current ratio..
2. Comparisons of Selected Ratios Between IFRS and US GAAP Companies
   • This study provides evidence of the effect of differences related to reporting inventory, property plant and equipment, intangible assets, and development costs between IFRS and US GAAP, showing that IFRS-country firms have a significantly higher current ratio.
   • (Bao et al., 2010).
3. International Financial Reporting Standards (IFRS) Application Peculiarities: A Case Study
   • This article discusses the main aspects of IFRS 5, "Non-current assets held for sale", and their application, using a Russian company as an example.
   • (Hajiyev et al., 2021).
4. Non-Current Assets Held for Sale in Terms of True and Fair View
   • This paper addresses how to present non-current assets held for sale to comply with the accurate and fair view principle, according to IFRS.
5. Evaluation of the Effect of Non-Current Fixed Assets on Profitability and Asset Management Efficiency
   • This article investigates the impact of non-current fixed assets on profitability and asset management efficiency, including detailed accounting treatments under IFRS.
6. Non-Current Assets
   • This chapter extensively analyses transactions in non-current assets and their effect on financial statements, with comparisons between IFRS and Romanian standards.
   • (Duțescu, 2019).
7. Accounting and Taxation of Transactions with Fixed Assets under IFRS and National Tax Legislation
   • The paper discusses the importance of compliance with IFRS in accounting for fixed assets. It provides insights into accounting policies for non-current assets.

Conclusion

Current assets are short-term assets that can be quickly converted to cash. They can be used to pay bills and support operations. 

The importance of them cannot be understated- they are vital in generating the cash flow necessary to keep an organization afloat. This is why they are listed at their net value on the balance sheet and included as part of calculating working capital. To learn more about financial reporting, take a deeper dive into IFRS or USGAAP certification with one of our ACCA or AICPA online courses.