Current assets are the cash and assets a company has for near-term operations

Whether an asset gets classified as a current or noncurrent asset depends on how long the company expects it will take to turn the asset into cash.

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• Current assets are assets that a company expects to use or turn into cash within a year.
• Cash, short-term investments, accounts receivable, inventory, and supplies are common examples.
• A company's current assets and related financial ratios offer insight into its financial health.
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In accounting, a company's current assets include the cash it has on hand and the other assets that will soon be turned into cash. Current assets can be important because even if a business is on track to achieve long-term success, it could wind up falling short if it doesn't have enough money available to cover short-term expenses. 

What are current assets?

"Current assets are the category of a company's resources that are expected to be used over the course of normal business operations over the near term, less than one year into the future," says Matt Stucky, a senior portfolio manager with Northwestern Mutual Wealth Management Co.

Stucky says a company's current assets can offer a lens into how much liquidity the company will have to fund its everyday operations and meet near-term financial obligations. These short-term assets could include the money a company will use to pay employees or buy supplies, along with the inventory it's currently selling to customers.

In contrast, a company's fixed assets may include the land, buildings, and machinery that it will use for longer than one operating cycle, such as a year. Noncurrent assets can also include intangible assets, such as copyrights or trademarks, that won't likely or can't easily be quickly turned into cash. 

Current assets are combined with noncurrent assets to make up the company's total assets on its balance sheet.

How current assets work

Whether an asset gets classified as a current or noncurrent asset depends on how long the company expects it will take to turn the asset into cash. Assets must be used or converted within a year (or, within one operating cycle if that's longer than a year) to qualify. 

Current assets are also often liquid assets, meaning they can quickly be sold for cash without losing much value. Some assets are easy to classify, such as cash and US Treasury bills, which mature in a year or less. But others may seem more ambiguous if you're not familiar with accounting practices. 

For example, prepaid expenses — such as when you pay an annual insurance premium at the start of the year — could be considered current assets. As could accounts receivable — the money that customers owe the business for products or services that have been delivered.

Note: Managing a business's cash flow, when the company receives and pays cash, is an important part of building a successful company. Current assets and liabilities are a component of this, but they won't necessarily show you the day-to-day financial obligations.

Understanding a business's current assets and whether it can cover its short-term liabilities is an important part analyzing the company's financial position. Businesses that can easily pay their debts or have funds to take advantage of opportunities may be more likely to survive and thrive in the long run. 

What types of current assets might a company have? 

Common examples of companies' current assets include: 

• Accounts receivable
• Cash
• Cash equivalents
• Inventory
• Prepaid expenses
• Short-term investments
• Supplies

Sometimes, whether an asset gets classified as current or fixed can depend on the business. 

For example, a company that builds manufacturing equipment might consider the completed units as inventory and classify them as current assets. However, a company that buys the machinery and will use it for years to come would consider it a fixed asset. 

Using current assets to analyze companies

"Current assets are one of the first steps in assessing the financial soundness of a company," says Stucky. "But analysts go much further and assess those current assets against current liabilities … financial obligations that a business expects to incur over the near term." 

Analysts may also use a company's current assets and other financial information to calculate financial ratios that are commonly used to better understand companies' financial positions. 

Balance sheet

To find a company's current assets you can look at its balance sheet, one of the main financial statements. "Both current assets and current liabilities are found every quarter on a company's balance sheet statement," says Stucky.

The asset section may be broken into current and noncurrent assets. And the current assets may be further broken down and ordered based on their liquidity — how easily they can be converted into cash. For example, cash and cash equivalents may be listed first, while inventory and accounts receivable could be further down. 

Financial ratios

A company's current assets can also be inputs for different financial ratios. Commonly used ratios that involve current assets may be considered liquidity ratios because they offer insight into a company's near-term finances: 

• Current ratio (current assets / current liabilities). The current ratio, sometimes called the working capital ratio, measures a business's ability to cover its short-term liabilities. 
• Quick ratio (quick assets / current liabilities). The quick ratio, sometimes called the acid-test ratio, compares a subset of current assets that can be converted to cash within 90 days to its current liabilities. 

In both cases, a ratio below one could indicate the company will struggle to cover its short-term liabilities. A higher number may be better. However, there are diminishing returns and companies that have high ratios might not be effectively using their capital to run or grow the business. 

"Going further, investors like to measure how current assets and liabilities evolve over time in relation to other fundamental considerations, like sales growth or earnings," adds Stucky. "For example, it's not a good situation if sales are slowing over time if inventories (a current asset) are rising."

The financial takeaway

Companies that don't have enough liquidity may struggle with a cash flow crunch or lose out on opportunities to expand. Reviewing a company's current assets, liabilities, and related financial ratios can give you insight into whether a company may fail, survive, or thrive. 

Stucky says, "investors want to see current assets and current liabilities move appropriately in relation to the company's sales and earnings profile. Lower levels of current assets relative to sales imply an efficient operation, but shouldn't be a headwind to a company's growth trajectory." 

Also, make sure you're comparing a company to its peers. Expected or average financial ratios may vary depending on the business, and depending on where it is in the business life cycle.

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Contributer : Business Insider https://ift.tt/3DCZaA4

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