Assets are the possessions that an entity owns. It is majorly classified into current assets and noncurrent assets and they are categorized as tangible and intangible assets and further categorized into operating which are used for core activities that aids revenue and non-operating assets which are part of what company owns but are not put into any operational activity of the business. A company should have more assets than liabilities. Assets are valued differently. Some are valued at market price and some are recorded at fair value. Assets help the company to gain profit in the lifetime of the company. So it always aids the economy now and in the future that’s why it is said to carry the economic benefit of a country. Now we are going of look at current assets. Noncurrent assets will reach you soon
Current assets are liquid assets which can be turned into cash easily. These liquid assets are used to fund the day-to-day activities of the business. They are short-term assets as they are converted into cash within the accounting period or twelve months to fulfill the obligations of the entity without external resources. Such as Trade receivable, Inventory, Short-term investments etc. As short-term assets fund day-to-day activities they are classified under trading account, whereas fixed assets are classified into capital gains/ capital losses once they are sold. The current assets do not undergo depreciation.
Current assets= Short-term investments+Inventory+Trade receivable+Cash and Cash equivalents+Prepaid expenses+Other current assets
When a business makes trade and sells its goods and services for credit then the amount of goods for which the money is due is still a part of the company’s asset. If they are settled within a 12 months period they come under trade receivables. When customers fail to pay back within the period they are debtors. These debtors are then put under bad debts if they fail to pay the whole money forever. In the above given example the company has reduced its credit period to its customer for cost saving, So the trade receivables has shed from Rs.12,110Cr. to Rs.7,483Cr.
What are Cash and Cash Equivalents?
Cash and cash equivalents which are equal to cash as they are easily liquidated are short-term assets such as cash in hand, bank balance, bank deposits and marketable assets which can be liquidated as soon as possible. They are tangible and operating assets of the entity. In the above given example the company’s liquidity has enhanced. The cash and cash equivalents rouse from Rs.3,768Cr. to Rs.8,443Cr
What are Short-term Investments?
The money invested in investments like debentures, bonds, equities, government securities, and mutual fund investments are classified as short-term investments as these investments can be converted into cash within 12 months from the investment date and are classified as short-term investments. Investment is a tangible asset which can be touched, felt and seen. As investments are always kept ready to sell they are considered to be non-operating assets. In the above given example the short-term investments of the company rises from Rs.59,640 Cr. To Rs.70,030 Cr.
What are Prepaid expenses?
When a payment is made prior for any benefit in the future then the money paid is still our asset. As we still did not receive any goods or service in return. Till the service or goods are handed over to the company, the expense comes under prepaid. It is an inṭangible asset of the firm but are held up in core activities of the business so they come under operating assets.
What is an Inventory?
It is the stock that the company shall use for production and sale to earn profit. In manufacturing sectors good, raw materials, tools are always held readily for trade. They are tangible and operating assets. They can be liquidated within a short period. Some companies cannot sell its goods within the 12 months periods which are exceptional cases.
Wondering why loans come under current assets? They are a part of liability. In contrast to investing, why not a company lends money to its staff and customers? Take for instance automobile companies, no hot cash while cars are getting unloaded. Yes, they avail credit facilities, but some companies provide loans in the name of companies for being customer friendly.
Financial health & Financial ratios
As we know current assets are also known as liquid assets, we can predict liquid ratio plays its role. The following ratio says how far a company is able to meet its short-term obligations with short-term assets.
To know how far a company can immediately pay off debts with cash and cash equivalent. Cash and cash equivalents are divided by Current liabilities in order to get the cash ratio that a company has.
Cash ratio = Cash and cash equivalent / Current liabilities
A good company should always have a cash ratio equal to or above 1 which indicates that there are enough assets to pay off debts. Equal to 1 represents equal amounts of debts and cash. Less than 1 indicates that the business has more debts and the company is not good at liquidating, but on the other side, even if the company does well, it might be using funds for development so might be out of cash. So cash ratio might not be a sole indicator to decide a company’s financial health.
To evaluate how far the company is able to meet its short-term obligation with quick redeemable assets the current assets are divided by current liabilities.
Similar to cash ratio 1 represents that the assets are able to cover the liabilities. A company with less than 1 is not healthy.
Current ratio= Current assets/Current liabilities
This ratio is similar to the current ratio, but the inventory held for sale and the prepaid expenses are excluded. This ratio is used for a quick liquidation without selling the goods and future benefits.
Quick ratio = Current assets-(Inventory+ Prepaid expenses)/Current liabilities
Similar to the ratio given above, a company with less than 1 is unhealthy as the company is facing difficulty to cover its debts. So it’s always better to keep the number above 1.