Current assets in financial statements: An analysis guide for investors

Understanding the Structure of the Balance Sheet through Current Assets

Value-focused investors need to understand how to read financial statements, which are key to assessing an organization’s strength and business potential. Financial statements consist of several components, and in this article, we will focus on the often-overlooked component: Current Assets, which help investors analyze a company’s ability to overcome financial crises clearly.

What are Current Assets: Meaning and Importance

When studying the (Balance Sheet), you will find that assets (Asset) are divided into two main categories: Current Assets (Current Asset) and Noncurrent Assets (Noncurrent Asset).

Current Assets refer to assets that the company can convert into cash or cash equivalents within a period of no more than 1 year. The key aspect of these assets is measuring the company’s short-term management capability during crises. When emergencies occur, such as liquidity shortages, the company can immediately utilize these assets. The more current assets a company has, the better its potential to withstand financial shocks.

The difference between current assets and noncurrent assets lies in how easily they can be converted into cash. Current assets can be quickly turned back into cash, indicating the company’s short-term liquidity. They are easy to rotate. Noncurrent assets, such as land, buildings, and machinery, need to be held for more than a year and are not easily converted into cash during crises but are vital for long-term business operations.

How are Current Assets Classified?

Current assets include various types, each with different characteristics and risks:

Cash (Cash) is the most liquid asset, with no time or difficulty in utilization. The downside is that it does not generate any return. Therefore, holding excess cash is not considered good asset management.

Cash Equivalents (Cash Equivalents) are assets similar to cash and can be quickly converted back into cash. Although there is some risk related to the liquidity of financial institutions, they offer the benefit of earning interest.

Short-Term Investments (Short Term Investment) are investments planned to be held for no more than a year and can be liquidated quickly, such as stocks, securities, gold, bonds. While they carry additional risks, they can generate returns for the company.

Notes Receivable (Notes Receivable) are contractual documents mainly serving as evidence of loans or transactions, with a period not exceeding 1 year. Although there is a risk of default, they can also accrue interest, increasing investment value.

Trade Receivables (Receivable) refer to amounts owed by customers for goods or services received. This is usually to facilitate smooth trading, but during crises, some customers may delay payments.

Inventory (Inventory) includes raw materials and finished goods awaiting sale. They can be converted into cash through sales. Investors should study whether inventory levels are decreasing or increasing, as excessive stockpiling can turn into sunk costs.

Supplies (Supplies) include consumables used daily in business operations.

Accrued Revenue & Prepaid Expenses (Accrued Revenue & Prepaid Expenses) are revenues expected to be received and expenses paid in advance to gain benefits in the future.

How to Analyze Current Assets from the Balance Sheet

The current assets section appears as the first item of assets (Asset) on the balance sheet, detailing various asset types with their amounts. Investors can use this information to assess the company’s short-term liquidity.

The value of current assets indicates how capable the company is to manage in emergency situations. During temporary income halts, such as during the COVID-19 pandemic, companies need to use current assets to pay for machinery maintenance, employee wages, and other expenses until income resumes.

Additionally, the quality of current assets is crucial. Some assets can be reliably converted into cash even during crises, such as deposits and notes receivable, while trade receivables may not be collectible if customers face financial difficulties. Investors should delve deeper to understand the quality of the company’s current assets and how they can serve as risk mitigation tools.

Case Study: Apple Inc.

Apple (APPL) is one of the highest market value companies in the US stock market and is known for excellent liquidity. In the early 2020 shareholders’ meeting, at the start of the COVID-19 crisis, Tim Cook, Apple’s CEO, stated that liquidity was not a problem for the company.

Analyzing Apple’s balance sheet at the end of 2019, the company had total current assets of $162,819 million, with cash and cash equivalents (Cash & Cash Equivalents) valued at $59 million.

However, compared to 2020, total current assets slightly decreased from $143 million to $135 million. Notably, the composition changed: cash and cash equivalents decreased from $90 million to $48 million (down 46%), while trade receivables (Receivable) increased from $37 million to $60 million (up 62.7%).

This change suggests that Apple may have adjusted its collection policies or faced difficulties in collecting from buyers. A deeper analysis of these changes is essential for risk assessment in investment decisions.

The Importance of Analyzing Current Assets

Investors must understand that merely looking at the total current assets is insufficient. The current assets on the financial statements provide an overview of short-term liquidity, but the quality of these assets requires deeper investigation.

Investors should study:

• What types of assets comprise current assets
• The risk levels of each type
• Whether these assets can be reliably converted into cash even during crises
• Whether there are changes in the composition of current assets year over year

Such detailed analysis helps investors make informed investment decisions and reduce risks. Assets of good quality and easily convertible into cash, even in unforeseen circumstances, are strong indicators of a company’s financial health.