A company’s balance sheet comprises three important components that present an idea about a business’ performance in any given fiscal year. It lists a company’s assets, liabilities and shareholders’ equity, which offer relevant entities insight into the company’s solvency. In this regard, assets included under the balance sheet denote those resources that increase the company’s value and benefit its operations. Assets, in turn, can be of several types, of which current assets are a crucial component.
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What are Current Assets?
Current assets refer to the category of company resources that can be converted into cash in any given fiscal year. To elucidate, these refer to a company’s assets that can be consumed, sold, used, or exhausted through a business’s operations in a particular year.
These assets can include cash equivalents, cash, stock inventory, accounts receivable, marketable securities, and such other liquid assets. When these components are represented in a balance sheet, they are sorted by way of their liquidity, meaning that the more liquid assets are put on top of the list.
Components of Current Assets
While cash, cash equivalents, alongside liquid investments in marketable securities are included under the purview of current assets, the following also comprise the types of current assets –
The term ‘inventory’ is used to denote raw material, finished products and other such components that companies hold with a goal for reselling. However, considering inventories under the current assets list can be tricky as few types of inventories may be illiquid, depending on the industry sector of the company.
- Accounts receivable
Accounts receivable denote the amount that is owed to the company for goods delivered but remains unpaid for by customers. However, when it comes to accounts receivable, only the amount that a company expects to receive in the particular fiscal year is accounted for in the balance sheet.
For businesses making sales by offering long term credits to customers, a certain percentage of the accounts receivable will not be considered as a current asset.
- Prepaid expenses
This component represents the payment that a company makes for goods and services that are scheduled to be received in the future. While they cannot be converted to cash, their expenses are already paid for, thus mandating their inclusion under the current asset classification.
Alongside these, current assets also include petty cash, cash at bank, cash in hand, cash advance, short term staff loan, short term investments and such. The simple summation of these assets proffers the total valuation of the assets type for a company.
Following is an example that can help understand current asset meaning better.
Calculation of Current Assets
The formula for calculating the total of current asset types can be given by –
Current Assets = Cash [C] + Cash Equivalents [CE] + Inventory [I] + Accounts Receivable [AR] + Marketable Securities [MS] + Prepaid Expenses [PE] + Other Liquid Assets [OLA]
Now, for example, in December 2019 Company ABC had –
Rs.5,00,00,000 in cash [C]
Rs.20,00,000 in cash equivalents [CE]
Rs.4,00,00,000 in marketable securities [MS]
Rs.2,00,00,000 in accounts receivable [AR]
Rs.2,50,00,000 in inventory [I]
Rs.1,00,00,000 in prepaid expenses [PE]
Rs.1,50,00,000 in other liquid assets [OLA]
Thus, the consolidated balance sheet of the company for 2019 will look like –
|Assets||Value (in Rs.)|
|Cash and cash equivalents||5,20,00,000|
|Other liquid assets||1,50,00,000|
Therefore, the total of Current Asset type for Company ABC in December 2019 will be = Rs.16,20,00,000
Usage of Current Assets
Calculating the current asset total for a company in any given fiscal year is crucial for any company’s management pertaining to its daily operations. Since most of a company’s payments towards various loans and bills are made towards the end of a month, the management must have an idea about how much cash they can comfortably spend at that time. Calculation of current assets allows companies to gauge their liquidity position and consequently helps the management to undertake necessary steps to continue operations without hassle.
Furthermore, these short-term assets of a company also allow investors and creditors to assess the value and risks involved in the operations of a business. In this regard, these assets are also utilised to calculate several types of liquidity ratios. Valued so calculated help determine a debtor’s potential to meet their debt obligations without having to resort to external capital.
Financial Ratios that Use Current Assets and Their Components
Following are a few liquidity ratios that are calculated utilising the total or a part of the current asset in total –
- Cash ratio
This liquidity ratio allows firms to gauge their ability to meet short-term liabilities. It is a conservative ratio, calculated by utilising examples of current asset components like cash and cash equivalents. The formula for cash ratio is given by –
Cash ratio = Cash and cash equivalents/Current liabilities
- Current ratio
The current ratio helps to measure a firm’s ability to meet both its long and short term financial liabilities. It is calculated by utilising a formula that accounts for all of a company’s immediate assets –
Current ratio = Current assets/Current liabilities
- Quick ratio
Also known as the acid-test ratio, it helps companies to measure their capacity to meet short-term pecuniary liabilities. The calculation of this liquidity ratio is done by using assets that can be effectively converted to cash within 90 days.
Quick ratio = (Cash and cash equivalents + Accounts receivable + Marketable securities)/current liabilities
Calculation of current asset total is, thus, extremely crucial to understand a company’s ability to meet its financial liabilities both in the short and long term.
Differences between Current and Non-Current Assets
The following table illustrates the differences between current and non-current assets –
|Parameters||Current Assets||Non-Current Assets|
|Liquidity||These are assets that can be converted to cash within a year.||These assets are not converted into cash within a year.|
|Components||These assets consist of cash and cash equivalents, inventories, accounts receivable, short term investments, etc.||Non-current assets include goodwill, PP&E, long-term deferred taxes, depreciation and amortisation.|
|Valuation||Such assets are valued at their market price.||These are valued at their cost minus the depreciation.|
|Usage||Companies utilise their current assets to fund their immediate needs.||These assets are utilised to fund future or long-term needs.|
|Revaluation||These assets (barring inventories) are mostly not subject to revaluation.||Components of non-current assets like PP&E are re-valued frequently.|
A company’s management must account for both current and non-current assets to gauge an organisation’s repayment abilities. Furthermore, investors should also take note of these factors to understand a company’s value and operations better.