If you are new to the world of the stock market and investments, current assets are the best topic to start gaining knowledge on.
The company balance sheet enlists three significant components, assets, liabilities, and shareholders’ equity. These company components reflect its business performance in any given fiscal year. These also offer valuable insights into the solvency of the company. The assets written in the balance sheet correspond to those resources that benefit the company’s operations and increase its value. Assets are of various types, of which current assets are the most essential.
The resources a company sells or uses for business operations in the next financial year are known as current assets. It includes cash, cash equivalent, stock inventory, pre-paid liabilities, accounts receivable, marketable securities, and other liquid assets. These assets pay for the daily operations and the ongoing business procedures. Hence they are of immense value for a company. The company can sell and consume these resources without difficulty to further lead to the conversion of liquid cash. In other words, these are the resources which will last for a year or less.
Current assets belong to a company’s resources category you can convert into cash at any time in a given fiscal year. They are sorted by their liquidity when represented in a balance sheet. That is, the most liquid asset occupies the top place in the list.
These assets are the exact opposite of long-term assets. A company cannot feasibly convert long-term assets into cash in a year. Examples of such assets are equipment, land, facilities, copyrights, and other illiquid investments. These current assets last only for a year or less. Current resources can range from fabricated goods, raw materials, barrels of crude oil, work-in-progress inventory, or foreign currency based on the nature of the business and products a company sells.
Current resources are vital for the functioning of a business. Companies can use these to fund the day-to-day operations and pay for the daily operating procedures. These resources also reflect the company’s liquid assets. Since the term represents a dollar value of all the resources that can easily yield cash in a short time frame.
However, companies must be careful while listing the current resources they own. Include only those assets you can liquidate at a fair cost over the next year. For example, there is a giant probability that a company can sell its commonly used fast-moving consumer goods (FMCG) hassle-free in the next year. Although inventory is available on the list, heavy machines may be tough to sell. So it is better to exclude them.
Many types of current assets differ by industry. Generally, the assets considered as current resources in most industries are as follows.
Let us discuss each one in detail.
A business needs cash to operate. Hence it is a must current asset. It includes paper money, coins, checking accounts, money orders, and deposited receipts. Companies use excess cash to generate more income. Businesses can achieve it by investing in low-risk and highly liquid set-ups. Cash equivalents refer to money market mutual funds, commercial paper, treasury securities, and bank certificates of deposits.
The securities traded heavily on public exchanges are known as marketable securities. You can readily find buyers for marketing security. So these short-term assets qualify well to fit the list of current resources. There are generally two types of marketable securities, namely debt and equity securities.
Accounts receivable is one of the types of current assets, which refers to the money due to a business for services delivered or goods sold but not yet paid by the consumers. Whenever you expect the capital to get paid in the current year, these are known as current resources. If, however, your company offers products and services to customers on long credit periods, a part of accounts receivables will not qualify to be present in current resources.
You may never get paid in full for specific accounts. Allowance for doubtful accounts reflects upon this consideration. It gets subtracted from accounts receivable. A never paid account is a bad debt expense and cannot be a current asset.
Another common inclusion in the company’s current assets is raw materials, finish products, and components, collectively known as inventory. But you need to think carefully about the consideration of this item in the list. You can inflate the inventory by several accounting methods. In many industries, inventory is not as liquid as other resources because of the product getting manufactured.
For example, there are few chances that a company will be able to sell a dozen units of high-cost heavy machinery in the next year. But there are fair chances that a company will successfully be able to sell a thousand umbrellas in the coming rainy season. In comparison to accounts receivable, inventory is not a liquid resource. It also blocks the working capital. Inventory can become backlogged if there is an unexpected shift in the demands. But this is more common in some sectors than others.
A company makes advance payments for certain goods and services to use in the future. These are prepaid expenses and find a notable place in the list of current resources. You cannot generate cash from it, but you have already paid for it. It means you need not worry about the payments of certain things this year, thus freeing up the capital to use elsewhere. These may include payments done to contractors and insurance companies.
The receivables from employees, vendors, and other entities for non-trade work constitute non-trade receivables. The company may get some prepaid deposits from vendors, loans or salary deposits from employees, and tax refunds from tax authorities. These enter under current assets componentsif these are to get paid within one year.
Other current assets a company holds are any resources they can convert into cash in one fiscal year.
The balance sheet mentions these items in their order of liquidity. The most liquid resources occupy the top positions of the list, followed by the less liquid ones. In other words, assets with higher chances of being converted into cash are always above. The typical order in which current assetsexist is cash, short-term investments, accounts receivables, inventory, supplies, and pre-paid expenses.
The formula of current resources is derived by adding all the assets mentioned on the balance sheet that can be converted into cash easily in a time frame of a year or less. These primarily include cash, cash equivalents, inventory, accounts receivables, prepaid expenses, and more. Adding these with other liquid resources will help in analysing the short-term liquidity of a business.
Current assets = cash and cash equivalents + accounts receivables + inventory + prepaid expenses + marketable securities + other liquid assets.
The above calculation formula is derived from the simple steps mentioned below:
There can be situations when businesses want to quickly increase their current resources. Such as in a non-ideal case where the current liabilities become more than the assets. Although this might be a temporary phase, it is not at all good for your business. A company may consider actions in these situations like selling short-term investments and collecting accounts receivables from the customers. This will help in restoring an imbalance between the current liabilities and the current assets.
It is important for a company to accurately calculate its current resources to get an idea of the funds available during a particular time. We cannot stress enough the fact that these calculations are especially important when analysing a business’s short-term solvency. Here are some examples that will help you understand the process better.
Example-1
Let us consider a software company X wants to calculate its current assets. They tabulate the following results by examining their accounts.
Current Assets | Description | Value |
Cash | The total cash available in checking and savings accounts. | Rs.1,000,000 |
Inventory | The total worth of software that they can move at any given time | Rs 2,500,000 |
Accounts Receivable | The outstanding accounts that you can liquidate in the current year | Rs 500,000 |
Prepaid expenses | The company does not pay for any service in advance. None of the employees works at the office; all work from their homes. Monthly insurance gets paid. | 0 |
Short-term investments | You can transform the stocks into cash this year. | Rs 1,250,000 |
Other liquid assets | The company owns US treasuries that will mature this year. | Rs 50,000 |
The current assets of the X software company will be the sum of the third column of the above table. Current assets = Rs(1,000,000 + 2,500,000 + 500,000 + 1,250,000 + 50,000) = Rs5,300,000. This number represents their financial health in front of the investors.
Example-2
Let us now look at the current asset calculations of a small bakery Y. You can obtain from their balance sheet:
Current Resources | Description | Value |
Cash | The bakery has some cash available inside the building and some in savings & checking account | Rs 12,200 |
Accounts Receivable | These are the unpaid invoices of the bakery’s customers. They can call the local retail partners to liquidate these assets. | Rs 2,000 |
Inventory | It includes direct inventory and raw materials available in the bakery at any point in time. | Rs 1,300 |
Short-term investments | The bakery is a small business and thus does not own any investments yet. | 0 |
Prepaid expenses | They have prepaid one-year insurance. It is a part of current resources because it counteracts a part of expenses. | Rs 1,200 |
The value of current resources of the bakery will be Rs 12,200 + Rs 2,000 + Rs 1,300, + 0 + Rs 1,200) = Rs 16,700.
Example-3
Here we will calculate the current assets of a sole proprietor who deals in furniture as a side gig. It will help him determine if he can opt for it full-time or not.
Current Resources | Description | Value |
Cash | The furniture seller has some cash in his business checking account from his recent sales. | Rs 500 |
Accounts Receivables | He takes payment of all orders simultaneously. So no invoices are due. | 0 |
Inventory | He has three tables, two chairs, an armoire, and raw materials in his workshop. | Rs 3,950 |
Short-term investments | His business has not been profitable enough to make any short-term investments. | 0 |
Prepaid expenses | He has paid the rent of the workshop for the next six months. | Rs 7,200 |
The furniture maker has Rs 12,900 in current resources. He can use this figure to know the future of his business by comparing it with short-term liabilities.
The ratio of current assetsto current liabilities is essential in a business as creditors use this information to determine the short-term liquidity of an entity. A company is working ideally when its current resources exceed the current liabilities. Some uses of current assets are:
You can manage a company well if it owns more current assets. It is because you can have more cash for day-to-day business operations. Over accumulation, this will prove to be of higher value, as is the time value of capital. Whereas deficiency of a resource like inventory can disrupt the business procedures. At the end of each month, you have to pay bills and loans. Likewise, the company must have the necessary cash to pay the outstanding bills. Its dollar value represents the total cash and liquidity position of the business. Also, knowing this helps prepare well for the required arrangements for a smooth operation.
You can usecurrent assets to determine numerous ratios such as working capital ratio, current ratio, liquid ratio, and many more. These help in financial statement analysis. Stakeholders carefully witness these ratios before investing in a company. Liquidity ratios determine the debtor’s ability to return the loan amount. Investors decide the dividend payments of the business using the dividend pay-out ratio. You can use this information for the analysis of different domains.
The current ratio is a financial metric that stockholders and investors use to assess the firm’s ability as a borrower and its future in the market. It offers a perfect firm evaluation of current assets vs current liabilities. Ideally, the current resources of a company must exceed its current liabilities. It is also known as the working capital ratio. It is one of the few liquid fractions that gauge a company’s ability to use cash and equivalents to meet the immediate working capital requirements.
The current ratio’s two primary components are current liabilities and current assets. Current assets include cash, inventory, short-term investments, accounts receivables, prepaid expenses, and other liquid resources. Current liabilities include accounts payable, income taxes, outstanding wages, and declared dividends.
You can calculate your company’s current assets ratioby dividing a company’s total current resources by its total current liabilities.
Current ratio = Current Assets/Current Liabilities
The result determines the number of times the given company in consideration could pay off its immediate liabilities with its total current resources.
For example, if the value of current resources of a company is rupees 40,18,23,400 and value of total current liabilities is rupees 10,36,75,900, then its current ratio will be 40,28,23,400 divided by 10,36,75,900 which equals 1.57. The result reveals that the company can successfully meet its immediate liabilities, thus indicating favoured financial health. Investors and stakeholders are attracted to such companies.
The following are some examples of current assets:
Non-current assets are the resources intended for the longer term, and company cannot liquidate them immediately. So fixed or non-current assets are subject to depreciation, unlike the current resources. It is a small gist of current assets vs non-current assets.
Conclusion
Current assets are all the resources a company can sell, realise, or consume in a short time, generally one year. These are liquid assets that companies can transform into cash in hand. These assets are used as funds to support the business’s daily operations. A company must maintain adequate levels of assets. The most significant use of current assets is the calculation of the current ratio, which determines the financial health of a business. Stakeholders and investors look at this number before investing in a company. Ideally, the ratio should be greater than one.
No, fixed assets are not current assets. Current assets provide profit financially in one year. Fixed assets are something useful and kept for more than one year. Due to this reason, fixed assets are kept as long-term assets and known as non-current assets.
No, property, plants and equipment(accessories), also known as PP&E which does not fall under current assets. Current assets are the assets providing benefit within one year. PP&E have a timeline longer than a year. Due to this, they are considered fixed assets which makes them illiquid as they won’t be convertible to cash anymore.
According to the maturity of the bond (on the basis of time), they can be current assets or not. Bonds with short-term investment, i.e. US Treasury Bills, can be considered as current assets. If there exists some other type of bond on the company’s balance sheet for more than one year, it makes them non-current assets.
We can say that buildings are non-current assets. The buildings exist more than a year and henceforth the value which stays longer than a year. Interestingly, these are a part of PP&E, property, plants and equipment, which fall under the category of fixed assets.
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