Current assets are a category on the asset side of the balance sheet which majorly comprises of cash and bank balance, inventories, account receivables/debtors. Key features of current assets are their short-lived existence, fast conversion into other assets, decisions are recurring and quick and lastly, they are interlinked to each other. Virtually, current asset management is almost as good as working capital management.
The term current asset is formed with two words – current and asset. Current means circulating and asset means valuables. Current assets are those assets or valuables of a business which keep circulating. The typical time frame for circulation is the financial period which is normally one year.
In specific business language, current assets are those assets which are transformed into cash within one year. These assets include cash, marketable securities, account receivables/debtors, all types of inventory/stock and any other asset which can be converted into cash within one year.
MAJOR CURRENT ASSETS
There are three main components of current assets which require the considerable attention of the finance manager. Without effective management of these components, the manager cannot achieve effective working capital management. These are
Cash or Bank Balances
Cash and bank balance are the balance which a company holds for his urgent needs. This balance would keep fluctuating and a particular balance would not last for more than a week or two. The balance will be high when the collection is done by the customer and it will again reduce when payment is made for purchasing of raw materials.
Inventories forms all kinds of inventories whether that is raw material, work in progress stock or finished goods. The time frame of their conversion is also normally between 2 to 60 days and rest depending on the industry a company operates in.
These are the customer accounts to whom goods are sold at credit. This money is circulated normally within 30 to 60 days. This depends on a lot of the credit terms and the industry standards of such credit terms.
FEATURES OF CURRENT ASSETS
We just saw in the definitions of all the major current assets that they are very short-lived especially when we compare them with their counterpart i.e. Fixed Assets.
Fast Conversion Cycle of Current Asset
These assets are quickly converted into other current asset forms in a cyclic manner. The current asset cycle works as follows:
Cash converted into raw material, which again converts to finished goods, further that converts into account receivables and finally account receivables are converted back into cash.
Decisions are Recurring and Require Quickness
Since, the current assets are very short-lived and are frequently converted into other current assets, the decisions relating to such assets also recurring in nature and requires quick decision making.
A manager cannot consider one component individually and take a decision on it. If that is done, that will not work in favor of overall working capital management. These components are interlinked to each other as seen in the current asset cycle. For example, if a business is in need of cash, it will have to offer a discount to debtors for their faster realization whereas if a business has too much of finished goods inventory, it will try to sell it to debtors with liberal credit terms.
Is Working Capital Management as good as Current Asset Management?
In general, working capital management would involve effective management of current assets as well as current liabilities. But if we think from a different angle, we may find the statement correct. It would not be too wrong to assume working capital management as good as current asset management due to two reasons. One is that the investment in current assets is a substantial part of the total assets of the company. Secondly, the current liabilities are created only because the firm wants to create current assets.