Many investors pay close attention to the total current assets of companies. Such accounts reflect the businesses’ ability to meet their near-term obligations, without raising additional funds. The sum total of these assets can help inform investment decisions, when certain variables are also factored in.
Read on to find out more about current assets.
Also called current accounts, current assets are a sum of a company’s assets that could be converted to cash within one fiscal year, if needed, usually to cover short-term obligations.
They are commonly used by investors, creditors, and other stakeholders to gauge a company’s overall liquidity, and to some extent, their financial health.
Current assets accounts are listed on publicly owned companies’ balance sheets, which includes the businesses’ assets, liabilities, and shareholders’ equity.
The existence of current assets accounts is vital to day-to-day business operations; bills and loans that become due require necessary cash. To qualify as current assets, listed items must have no restrictions that hamstring their short-term liquidity.
A company that has an operating cycle of more than one year still can classify an asset as current — if the asset is converted into cash within that cycle.
Current assets are usually presented on balance sheets in their order of liquidity. In other words, the most liquid items are shown first. It makes sense, then, that any cash or cash equivalents will top the list. Because each company has the discretion to input assets differently, the order in which current assets appear might differ.
Current assets are usually followed on the balance sheet by non-current assets, which are discussed later.
There are key ratios that use current assets. Such liquidity ratios are employed to determine whether a debtor can meet current debt liabilities without having to raise additional funds. Those ratios include:
This is used to evaluate a business’s ability to meet its short-term obligations. Because it exclusively uses cash and cash equivalents, the cash ratio is known as a conservative debt ratio.
The ratio demonstrates the company’s ability, without having to liquidate other assets, to repay existing liabilities.
The formula is: Cash Ratio = Cash and Cash Equivalents / Current Liabilities
Also known as the acid-test ratio, the quick ratio is used to assess a company’s ability to meet short-term financial obligations. This ratio employs assets that can be expected to be converted to cash within 90 days.
The formula is: Quick Ratio = (Cash and Cash Equivalents + Marketable Securities + Accounts Receivable) / Current Liabilities
This liquidity ratio, which is the most accommodating and includes a variety of assets from the current assets account, is used to evaluate a company’s ability to meet both short- and long-term financial liabilities. In the calculation, the ratio uses all the company’s immediate assets.
The formula is: Current Ratio = Current Assets / Current Liabilities
Note that because the current ratio uses inventory, it can overstate liquidity. Remember that inventory may not necessarily be converted to cash within a fiscal year.
On a balance sheet, assets are divided into two classifications: current and non-current.
It’s been established that current assets are those that can be converted to cash within a year. Non-current assets, then, are those that cannot achieve such timely conversion.
Examples of non-current assets include deferred charges, long-term investments, property, equipment, and intangible assets such as patents and trademark (examples of current assets are discussed below).
Because they are held for longer periods and depreciate, non-current assets are valued at their purchase price. That’s as opposed to current assets, which do not appreciate and are valued at fair market value.
Note that some asset accounts might be listed on a balance sheet under current assets as well as non-current assets. That’s to cover assets such as marketable securities that might be tied up for an extended period.
Current assets vary according to industry and are usually listed in order of ease of liquidity. They generally fall under these subaccounts:
The current assets calculation is the sum of all assets that can be converted to cash within one year. It looks like this:
Current Assets = C + CE + I + AR + MS + PE + OLA
C = Cash
CE = Cash Equivalents
I = Inventory
AR = Accounts Receivable
MS = Marketable Securities
PE = Prepaid Expenses
OLA = Other Liquid Assets
Consider Walmart’s balance sheet for the period ending Jan. 31, 2017.
Current Assets and their values included:
Non-Current Assets and their values included:
Total current assets totaled 57,689,000. Added to the non-current assets, Walmart’s total assets came to 198,825,000.
Managers want to know whether bills, invoices, and other obligations will be covered, even if there are financial issues. This means that, if worse comes to worse, items can be liquidated to meet short-term responsibilities.
Meanwhile, creditors take note of the proportion of current assets to current liabilities. Why? Because it indicates an entity’s short-term liquidity. Essentially, having significantly more current assets than liabilities signals that a company should be able to handle its short-term obligations. Such analyses can include the use of any of the various ratios covered above.
There does remain a prevailing problem with using current assets as a liquidity measure: some current assets, including inventory, are simply not always that liquid. In addition, a company may have a sizeable number of delinquent invoices under accounts receivables that may never be paid. Such invoices, however, may be largely offset in the “allowance for doubtful accounts” portion of the balance sheet that represents the amount unexpected to be collected.
Therefore, investors and others would do well to closely scrutinize the contents of current assets to determine a company’s actual liquidity.
Normal investors might want to consider using Current Assets to release the potential of private market alternatives, which aren’t subject to the volatility of open markets. They can use them as a way to assess companies in which they might invest through venture capital, a type of alternative investment. Such investments are increasingly popular as ways to diversify portfolios against market shifts.
Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk.
In some cases, this risk can be greater than that of traditional investments.
This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform. However, that meant the potentially attractive gains these investments presented were also limited to these groups.
To democratize these opportunities, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other alternative investments.
Even when a company is on track for long-term success, current assets can be helpful if extra funds are needed for short-term expenses.
Having said that, examining the value of a company’s current assets can give investors important insight into a potential venture capital investment. In turn, such an alternative investment would diversify portfolio holdings and help guard against market volatility.
All securities involve risk and may result in significant losses. Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information.
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