Types of current assets include:
- Cash and cash equivalents
- Short-term investments
- Accounts receivable
- Merchandise inventory
- Prepaid assets
Current assets are “liquid”
“Liquidity” means how easily an asset can be converted into cash. For example, we consider short-term investments to be liquid because companies can sell them with a single phone call (or click on a website). They can quickly sell accounts receivable to banks. On the other hand, you can’t call goodwill liquid because it is very difficult to sell.
The technical definition of “current assets” is assets likely to be converted into cash within one year or one operating cycle, whichever is longer. You can define an “operating cycle” as the period of time from when a company first buys inventory or raw materials, until whenever the company actually collects cash from selling the finished product. Almost all companies have operating cycles of less than a year, and therefore simply define current assets as assets likely converted into cash within one year. However, some companies – such as wineries and ship builders – have much longer operating cycles. Therefore they define current assets as assets likely converted into cash within one of their (long) operating cycles. For example, if it takes five years to grow grapes, turn them into wine, age the wine, and sell it, then the winery would have a five-year operating cycle and everything likely liquidated within five years gets measured as current assets. (Get it? Wine? Liquidated?)
Using current assets to make money
All business assets should generate revenues and net income. Before purchasing any assets, think about how they will ultimately increase your profits and keep enough cash and short-term investments handy to pay your bills.