What are Short Term Assets?
Short-term assets (also known as current assets) are those assets that are highly liquid and can be easily sold to realize money from the market, typically within one year. Such short-term assets have a maturity of fewer than 12 months and are highly tradable and marketable. Examples include inventory, cash and cash equivalents, and account receivables, among others.
Managing short term assets diligently allows businesses to calculate multiple crucial ratios like turnover ratio, and current ratio, and act as an important metric to determine the liquidity of the company. It is vital to understand that too much capital allocated to this account in the balance sheet could indicate the underutilization of resources and poor financial health.
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- Short-term assets, also known as current assets, have short durability. It includes expenses, cash, securities, accounts receivable, and rent. Moreover, it also helps describe the company’s liquidation and daily business operations.
- They involve cash equivalents, debtors or accounts receivable, prepaid expenses, and short-term investments.
- Short-term assets are highly liquid, making them a good portion of the analysis. Any company cannot afford to have too many current assets on their balance sheet, cash in hand, and the bank.
- The current or short-term assets are convertible and usable. They are of physical form and are tangible.
Short Term Assets Explained
Short-term assets, often referred to as current assets, are a vital component of a company’s balance sheet. These assets are expected to be converted into cash or used up within a relatively short period, usually one year or an operating cycle, whichever is longer. They serve as a measure of a company’s liquidity and its ability to cover short-term obligations.
The management of short-term assets is crucial for maintaining operational efficiency and meeting short-term financial obligations. Striking a balance between optimizing these assets and avoiding excess inventory or uncollected accounts receivable is key.
Analyzing the composition and trends of short-term assets helps evaluate a company’s working capital management, efficiency, and potential liquidity risks. It also provides insights into a company’s ability to respond to sudden market changes or capitalize on new opportunities. Short-term asset management is integral to a company’s financial health, as it supports day-to-day operations while enabling strategic decisions for sustainable growth.
Hence, careful analysis of short-term assets and liabilities is highly necessary to keep a company operating efficiently. Also, current assets are highly used in ratio analysisRatio AnalysisRatio analysis is the quantitative interpretation of the company's financial performance. It provides valuable information about the organization's profitability, solvency, operational efficiency and liquidity positions as represented by the financial statements. of the company, which tells the user where the company is standing compared to its global peers.
Let us understand the concept and its intricacies through the examples below. They shall provide us a practical overview of the concept.
Example #1- Cash and Cash Equivalents
Cash and cash equivalentsCash And Cash EquivalentsCash and Cash Equivalents are assets that are short-term and highly liquid investments that can be readily converted into cash and have a low risk of price fluctuation. Cash and paper money, US Treasury bills, undeposited receipts, and Money Market funds are its examples. They are normally found as a line item on the top of the balance sheet asset. are the liquid cash present in the company’s current balance sheet of the companyBalance Sheet Of The CompanyA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.. It also consists of a certificate of depositsCertificate Of DepositsA certificate of deposit (CD) is an investment instrument mostly issued by banks, requiring investors to lock in funds for a fixed term to earn high returns. CDs essentially require investors to set aside their savings and leave them untouched for a fixed period. and cash in hand andthe bank.
Example #2- Debtors or Accounts Receivables
DebtorsDebtorsA debtor is a borrower who is liable to pay a certain sum to a credit supplier such as a bank, credit card company or goods supplier. The borrower could be an individual like a home loan seeker or a corporate body borrowing funds for business expansion. or accounts receivablesAccounts ReceivablesAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. are the unpaid money of the company against which an invoice has been raised, but the money has not yet been furnished to the company. That is why it is an asset for the company and has its certification and payment cycle.
Example #3- Prepaid Expenses
Prepaid expensesPrepaid ExpensesPrepaid expenses refer to advance payments made by a firm whose benefits are acquired in the future. Payment for the goods is made in the current accounting period, but the delivery is received in the upcoming accounting period. are expenses paid in advance for a future period by the company. That is the reason it is showing as an asset to the company. Examples of prepaid expensesExamples Of Prepaid ExpensesPrepaid expense examples will provide an idea of the various payments made by the company in advance for those goods or services which will be procured in future. Some of these include prepaid rent, advance salary and prepaid insurance. are office rent, generally paid in full for the quarter or a year as per the leaseLeaseLeasing is an arrangement in which the asset's right is transferred to another person without transferring the ownership. In simple terms, it means giving the asset on hire or rent. The person who gives the asset is “Lessor,” the person who takes the asset on rent is “Lessee.” agreement.
Example #4- Short term Investments
When the company has idle cash on its balance sheet, it is forgoing the opportunity costOpportunity CostThe difference between the chosen plan of action and the next best plan is known as the opportunity cost. It's essentially the cost of the next best alternative that has been forgiven. of investment for that idle cash. So, the company opts to invest the unused money in various short-term ventures such as mutual fundsMutual FundsA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etc or demand depositsDemand DepositsMoney deposited with a bank or financial institution that can be withdrawn without notice is known as a demand deposit. Due to the shorter lock-in time, it does not pay any interest or a nominal amount of interest..
Let us understand the advantages of managing short term assets through the points below.
- They are highly liquidLiquidLiquidity is the ease of converting assets or securities into cash. and used for working capital management of the companyWorking Capital Management Of The CompanyWorking Capital Management refers to the management of the capital that the company requires for financing its daily business operations. It is important for the company in order to maximize its operational efficiency, manage its short term liabilities and assets properly, avoiding the underutilization of the resources and avoiding the overtrading, etc..
- They are used for ratio analysis and peer group analysis. It also talks about the liquidity state of the company and how liquid the company is for repaying its short-term obligations.
- Having a good amount of current assets on the company’s balance sheet makes the company liquid in nature. Also, it tells us about the company’s plans as more cash and more retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company. are used for the future and further investment in the company’s future goals.
- Current or short-term assets are highly convertible and usable. They are of physical existence and are tangible.
Despite the advantages mentioned above, there are a few other factors that could prove to be a hassle for businesses. Let us understand the disadvantages of short term assets and liabilities through the explanation below.
- Too much of the balance sheet is tied up in the current assets; this can be a sign of the bad financial health of the company.
- Too much capital stuck in the company’s existing assets signifies its inefficient working capital, and the company is not properly using its current assets. It can cause a loss of market shareMarket ShareMarket share determines the company's contribution in percentage to the total revenue generated within an industry or market in a certain period. It depicts the company's market position when compared to that of its competitors. and business.
- Short-term assets are highly liquid, making them a good portion for analysis as any company cannot afford to have too many current assets on their balance sheet, especially cash in hand and the bank.
Short Term Assets Vs Long Term Assets
Managing short term assets and long term assets are two categories of assets found on a company’s balance sheet. They have distinct characteristics and functions. Let us understand the key differences through the comparison below.
Short Term Assets
- Expected to be converted into cash or used up within a relatively short period, usually one year or an operating cycle, whichever is longer.
- Primarily aimed at supporting a company’s day-to-day operations and meeting short-term financial obligations.
- Examples include cash, accounts receivable, inventory, prepaid expenses, and short-term investments.
- Provide liquidity and help maintain working capital to cover short-term liabilities.
Long Term Assets
- Expected to provide benefits to the company over an extended period, typically beyond one year or an operating cycle.
- Primarily contribute to the company’s productive capacity, growth, and value creation.
- Examples include property, plant, equipment, intangible assets, long-term investments, and goodwill.
- Serve as assets that generate revenue, contribute to operations, and enhance the company’s competitive advantage.
Frequently Asked Questions (FAQs)
Long-term assets have a long shelf-life, e.g., 10, 20, 50 years, etc. At the same time, short-term assets have a term of 1-2 years, up to 5 years. Therefore, one must refrain from converting long-term assets into cash as they are utilized for a few years. They are not used to satisfy short-term business needs. In contrast, short-term assets are used to fulfill short-term business requirements and converted into cash.
A prudent short-term allocation is essential for an individual as it assures earning a sufficient return, adequate liquidity, minimum risks, and taxes, along with helping to achieve financial objectives. Moreover, it also helps to align investments as per time horizon.
Short-term assets known as current assets are not depreciated. Long-term assets are depreciated as an expense over the period being used.
This article has been a guide to what are Short-Term Assets. Here, we explain its examples, advantages, and disadvantages, and compare them with long-term assets. You may learn more about corporate finance from the following articles: –