Company's current assets: A key factor indicating the financial strength of the business

Why Is It Important to Understand Current Assets?

For investors focused on value analysis, studying financial statements is an essential foundational skill. All components of the balance sheet carry significant meaning. But when it comes to indicators of a company’s ability to handle sudden crises, Current Assets (Current Asset) are among the most favored and widely studied.

Why is that? Because this figure helps interested parties clearly see the short-term cash flow stability of the company. When everything is moving forward, these assets are used to offset liquidity shortages if unforeseen events occur.

What Are Current Assets?

In the (Balance Sheet) section of assets (Asset), they are divided into two main categories: Current Assets and Noncurrent Assets (Noncurrent Asset).

Current Assets (Current Asset) refer to the value of assets and resources that the company can convert into cash within 12 months. This is a measure of the company’s resilience, with larger amounts indicating stronger protection against financial shocks.

The term “current” in this context suggests that these assets can move and change form easily, unlike noncurrent assets that are held long-term, such as land, buildings, or machinery, which may take time and involve complexity to convert into cash.

Types of Current Assets

Looking into a company’s balance sheet, you’ll find that Current Assets consist of various components:

Cash & Cash Equivalents (Cash & Cash Equivalents) are the most liquid assets. Cash can be spent immediately to pay debts. Cash equivalents, such as bank deposits or short-term low-risk investment securities, can be quickly converted back into cash. Although holding large amounts of cash yields no return and may cause the company to miss income opportunities, this is the cost of maintaining high liquidity.

Short-Term Investments (Short-Term Investment) include debt securities like bonds or equity securities such as common stocks, intended to be held for less than a year. These investments offer potential financial returns but come with price fluctuation risks.

Trade Receivables and Other Collectible Assets (Receivable) represent money owed to the company by customers or other parties. Usually arising from credit sales for flexibility, the risk depends on the debtor’s ability and willingness to pay.

Notes Receivable (Notes Receivable) with maturities under one year are contractual evidence of payment commitments, such as loan agreements or interest collection contracts from sales.

Inventory (Inventory) includes raw materials, work-in-progress, and finished goods awaiting sale. This can be converted into revenue; however, investors should monitor how long inventory has been held, whether it has depreciated, or if there have been sales issues. Unsold inventory may become a sunk cost, reducing future profits.

Supplies (Supplies) are consumables like paper, ink, pens, and other materials used in business operations.

Accrued Income & Prepaid Expenses (Accrued Income & Prepaid Expenses) are items the company expects to receive in cash or benefits soon, as revenue recognition and prepayments are already completed.

Reading Current Assets to Assess Short-Term Liquidity

By examining the current assets section of the balance sheet, investors can determine whether the company has enough resources to pay short-term debts and routine operating expenses. This figure is a diagnostic tool for assessing the company’s safety margin against crises. For example, during the global COVID-19 pandemic in 2020, many companies temporarily halted sales or collections but still needed to pay wages, rent, and maintenance costs. Large current assets became a vital lifeline in such situations.

Furthermore, the types of current assets matter. Cash or cash equivalents can definitely be converted into liquidity. Accounts receivable depend on collection efforts and may sometimes be delayed or uncollected if debtors face financial difficulties. Therefore, the quality of current assets is as important as their quantity.

An Example from Apple’s General Study

Apple (APPL) is known as one of the most highly valued companies by market capitalization and is confirmed to have very strong liquidity. In the early 2020 shareholders’ meeting, when COVID-19 was just beginning to spread, CEO Tim Cook assured that liquidity was not an issue for Apple.

According to the 2019 fiscal year-end report, Apple had total current assets of $162,819 million. Cash and cash equivalents accounted for $59 billion dollars.

Looking at the following year, in 2020, total current assets decreased from $143 billion to $135 billion dollars, a slight reduction. However, a closer look reveals:

Cash and cash equivalents decreased from $90 billion to $48 billion, a 46% drop. Meanwhile, accounts receivable increased from (billion to )billion, a 62.7% rise.

This change may indicate two things: first, the company may have extended credit terms to customers, or second, there may be a decline in collection efficiency from trading partners. Both scenarios are important for investors to monitor over time.

Summary

Current Assets serve as a bright indicator of short-term liquidity and the company’s resilience against crises. However, the figures alone in the financial statements are not sufficient.

Investors need to delve into the composition of current assets—identifying which parts are highly liquid cash, which are risky receivables, and which inventory might pose problems. The company must maintain enough of these assets to meet debt obligations and expenses smoothly, even during crises like ongoing economic downturns. For analysts, understanding these details is crucial for comprehensive assessment.