Current Assets

In accounting, a current asset is an asset on the balance sheet which is expected to be converted to cash, sold or otherwise used up in the near future, usually within one year, or one business cycle - whichever is longer. These assets are continually turned over in the course of a business during normal business activity. Current Assets are the first item listed under the asset column on the Balance Sheet. Because they are easily turned into cash, they are sometimes referred to as Liquid. Typical current assets include cash, cash equivalents, accounts receivable, inventory, the portion of prepaid accounts which will be used within a year, and short-term investments.

A company's creditors will often be interested in how much the company has in current assets, since these assets can be easily liquidated in case the company goes bankrupt. In addition, Current assets are important to businesses because they are the assets that are used to fund day-to-day operations and pay ongoing expenses. Depending on the nature of the business, current assets can range from barrels of crude oil, to baked goods, to foreign currency.

There are 5 major items included into current assets:

Cash and Cash Equivalents

It is the most liquid asset and refers to the amount of money the company has in bank accounts, Savings bonds, certificate of deposit, and money market funds. It tells you how much money is available to the business  immediately. Generally speaking more the cash the better it is as it can provide extra wiggle room when the time gets bad. At the same time too much cash is not necessarily a good sign. It may indicate money sitting idle or worse, simply a large loan taken by the company rather than its profits. It must be therefore considered along with other balances on the balance sheet. 

Short-Term Investments

These are investments that the company plans to sell shortly or can be sold to provide cash. They aren't as readily available as cash but do provide an added cushion if some immediate need were to arise. It includes securities bought and held for sale in the near future to generate income on short-term price differences (trading securities). Short -term investment allows a company to use its excess cash for generating some income without compromising on its short term liquidity.

Account Receivables (A/R)

 Companies routinely buy and sell goods and services on credit. Account receivables refers to the fund that customers currently owe to a company for the product/ service they have already received but not yet paid for. Although A/R is almost always turned into cash within a short amount of time, some customers aren't so diligent. Normally, companies have to write off bad accounts receivable if they've shipped goods or provided services to a customer unwilling or unable to pay. The company?s set aside some money also known as Allowance for Doubtful Debts, to cover the potential for these losses, based on any such problems it may have previously endured. Various methods are used to determine the most accurate estimate of bad debts that a company is likely to incur. Even with this allowance, companies may still have to take hefty writedowns, or convert part of their accounts receivable to a loan, if a big customer finds itself in trouble.

Inventory

These are the components and finished products that a company has currently in stock to sell to customers. Trading these assets is a normal business of a company. Depending on the business it can be anything ranging from wood, minerals, to toys, furniture, food items etc. It is classified as current asset based on the assumption that the inventory will be sold in near future turning it into cash.  The inventory value reported on the balance sheet is usually the historical cost or fair market value, whichever is lower. This is known as the "lower of cost or market" rule. Several other methods of Inventory Valuation such as First in First Out, Last in First out etc are used so as to give a more accurate inventory value.

Prepaid Expenses

Prepaid expenses are non financial assets which result when payments are made in advance of the receipt of goods or services. It may arise from payments for insurance premiums, leases, membership dues and subscriptions. They are initially recorded as assets, whose value is then expensed over time as the benefit is received, onto the income statement. At the end of each accounting period, adjusting entries are necessary to recognize the portion of prepaid expenses that have become actual expenses through use or the passage of time. For example  when a business pays $ 12000 for a year of insurance coverage. Initially it records the transaction by increasing the asset account (prepaid insurance) with a debit and decreasing another asset account (cash) with a credit. After one month, an adjusting entry is made to increase (debit) insurance expense for $100 and decrease (credit) prepaid insurance for $100.