CURRENT ASSETS-A LIQUIDITY INDICATOR

In our earlier post ' ASSETS-THE BACKBONE OF A COMPANY' we have discussed about ' current assets ' in a brief form.

Now let's understand it in a descriptive form:

• Current assets represents the short term assets of a company i.e assets which are liquified(or converted into cash)or consumed within a period of one year or its operating cycle*  whichever is longer.

*Operating cycle indicates the time period between the cash outflow for the purpose of purchase, manufacturing of goods and cash inflows from its sale.

Now for a more detailed understanding let's know about some accounting items which are included in this head:


(1) CASH AND CASH EQUIVALENTS

Cash is the most liquid form of an assets as it is already cash.
Cash includes coins,balance in saving account,money orders ,bank drafts etc.

Cash equivalents includes short term securities with a very short maturity period say about 3 months or less.
These are highly liquid investments.

(2) MARKETABLE SECURITIES

These include share ,bonds and other securities with a maturity period of less than 1 year.

(3) SUPPLIES
Supplies include stationery items as they consumed within one year.

(4) INVENTORY

Inventory is the most crucial (important) item in a business entity as it is the most important means of generating revenue.*

*Revenue means proceeds from sale of goods and services.

Inventory involves stock of items which are produced or purchased for the purpose of future sales.

Inventory is considered as current assets as it is assumed that it will be sold within 1 year .

(4) ACCOUNTS  RECEIVABLES

It involves amount to be received on a future date on account of credit sales.

The person or business enterprise from whom the amount is to be received is known as 'Debtors'which becomes a part of current assets.

A debtor may issue a document as a written promise to pay the amount.
Such a document is known as 'BILL RECEIVABLE'.It is also included in current assets.

(5)PRE-PAID EXPENSES

As the name depicts it means amount of expense which are paid in advance.

Now the question arises why an expense is treated as an 'asset'
The reason is that the consumption of such an expense will be done on a future date i.e company gets a firm hold on the benefits of that expense until the date when the expense was to be actually paid.

For example:A insurance premium of ₹ 6000 was to be paid for 6 months in a one month installment system(i.e ₹1000) but the company decided to the whole amount in the first installment.
In this case the asset side will increase by ₹5000 as ₹1000 will be consumed on first installment only and rest ₹5000 will be for prepaid expenses.
Now when second instalment comes prepaid expenses will be reduced by ₹1000 thereby reducing assets side to ₹4000 (₹5000-₹1000).