Current Assets Definition
Current assets are expected to be consumed, sold, or converted into cash either in one year or in the operating cycle, whichever is longer. They are usually presented in order of liquidity on the balance sheet and include cash and cash equivalents, accounts receivables, inventory, prepaid and other current assets .
What is Included in Current Assets?
#1 – Cash and Cash Equivalents
Companies need cash to run their day to day operations. Cash usually includes checking accounts, coins and paper money, undeposited receipts and money orders.
The excess cash in normally invested in low risk and highly liquid instruments so that it can generate additional income. This is called cash equivalents. Cahs Equivalents may include commercial paper, money market mutual funds, bank certificate of deposits and treasury securities.
Look at Microsoft 2007 Balance Sheet Assets – What is the % of cash & short-term investments as a % of “Total Assets”
As we note from above, MacDonald’s percentage of cash and short-term investments to Total Assets was 58.28% in 2007 and 69.7% in 2006.
#2 – Accounts Receivables
The credit given to the customer is known as Accounts Receivables. This means that the company has rendered services or deliverd the product to the customer, however, it has not collected the cash fully yet.
In Colgate, we note the following –
- 2014 – Net receivables is $1,552 mn, allowance is $54 mn; This implies Gross Accounts Receivables are $1,552 + $54 = $1,606 mn
- 2013 – Net receivables is $1,636 mn, allowance is $67 mn; This implies Gross Accounts Receivables are $1,636 + $67 = $1,703 mn
#3 – Inventory
Inventory means the goods and the material that is in stock. There are three Types of Inventory – Raw material inventory, work in progress inventory and finished goods inventory.
source: Colgate SEC Filings
We note that Colgate’s raw material inventory was $266 million, Work in progress inventory was $42 million and Finished Goods inventory was at $863 million in 2016.
#4 – Prepaid expenses
These are exactly what they sound like. If a company pays a $10 million insurance premium on the last day of the month in excel that will provide coverage for the entire month, the company will record a $10 million prepaid expense to account for the insurance expense it will show in the month that it already paid for.
source: Google SEC filings
We note from above that Google’s Prepaid revenue share, expenses and other assets have increased from $3,412 million in December 2014 to $37,20 million in March 2015.
#5 – Other Current Assets
Other CAs consists of other non-cash assets that are owed to the company within one year. Companies often combine small accounts into an “other” category. Detailed information on Other CAs may be included in the notes to the Financial Statements. Analysts should always check the notes in the annual report when these figures are relatively high and if they are unclear what an account represents.
Examples
Consider Apple’s last quarter of 2017, the total current assets are separately provided and listed for each of the last four years. Wherein we can see short-term investments which are quite liquid are the most of the chunk and inventories on the other hand which is less liquid are the least. Receivables here represent the cash that the company has already earned but yet to receive.
Apple Inc’s other CAs for the quarter that ended in Mar. 2018 was $12,043 Mil. Apple Inc’s quarterly other CAs declined from Sep. 2017 ($12,864 Mil) to Dec. 2017 ($11,337 Mil) but then increased from Dec. 2017 ($11,337 Mil) to Mar. 2018 ($12,043Mil).
Apple’s financials, Source: Company Reports
How to Analyze Current Assets on Balance Sheet
# 1 – Working Capital
Working capital helps the investor understand the liquidity position of the company.
Working capital formula = Current Assets – Current Liabilities.
Below is the Colgate’s 2016 and 2015 balance sheet.
Working Capital for Colgate (2016)
- CA (2016) = 4,338
- Current Liabilities (2016) = 3,305
- WC (2016) = 4,338 – 3,305 = $ 1,033 million
Working Capital for Colgate (2015)
- CA (2015) = 4,384
- Current Liabilities (2015) = 3,534
- WC (2015) = 4,384 – 3,534 = $850 million
We note from above that Working Capital requirements of Colgate has increased to $1033 million in 2016 as compared to $850 million in 2015.
#2 – Current Ratio
Current Ratios provide us details of how Current assets are placed as compared to Current Liabilities.
Current Ratio Formula = Current Assets / Current Liabilities
Please note Sears Holding current ratio below
Sears Holding stock fell by 9.8% due to continuing losses and poor quarterly results. As you can see from above, Current ratio of Sears has been dropping continuously for the past 10 years. It is now below 1.0x and does not look good.
#3 – Quick Ratio
If inventory and other current assets like prepaid expense are large, then it may skew the current ratio. Since such items are not liquid, it is wise to calculate another ratio called as a quick ratio that considers only cash and cash equivalents and accounts receivables. Considering only these two terms provide a better view of the coverage of short-term obligations.
Quick ratio Formula = Cash and Cash Equivalents + Accounts receivables / Current liabilities
Below is a quick comparison of Quick Ratio of Colgate’s vs P&G vs Unilever
source: ycharts
As compared to its Peers, Colgate has a very healthy quick ratio. While, Unilever’s Quick Ratio has been declining for the past 5-6 years, we also note that P&G Quick ratio is much lower than that of Colgate.
#4 – Cash Ratio
Cash ratio is used to measure the liquidity of the firm and gives us a quantitative relationship between cash & cash equivalent with the current liabilities of the company.
Cash Ratio Formula = Cash + Cash Equivalents / Total Current Liabilities
source: ycharts
If we look at the above graph, we note that Starbucks has the highest cash ratio (0.468x in FY2016) as compared to Colgate and Procter & Gamble
Conclusion
Current Assets can be defined as a firm’s ability to convert the value of all assets into cash within a year. If a company has cash, short-term investments, and cash equivalents, they would be able to generate better returns just by using such Assets. It can range from businesses like retail, Pharmaceuticals, or oil depending upon its nature.
Even the value of a firm, the financial health of a firm is determined by a company’s current assets. That’s why using such Assets makes it a great way to evaluate a firm’s ability to provide funding to its operations.
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This has been a guide to what is current assets and its definition. Here we discuss what is included in Current Assets on Balance Sheet example along with the practical explanation. We also see ways to analyze such assets using ratios like working capital, current ratio, quick ratio and cash ratio. You may also have a look at these recommended articles below on basic accounting –
