Cash Investments Accounts Receivable And Inventory Are


Not All Current Assets Are Equal


When analyzing a company balance sheet, understand that not all current assets on the balance sheet are equal. For example, a company might place money in instruments such as auction-rate securities, a sort of variable-rate bond, which they treat as safe cash alternatives. But the market for those instruments could dry up, and it could take weeks or monthsor even longerto be able to convert them back into cash, making them unexpectedly illiquid.

As an investor, it pays to be wary of exposing your portfolio to a firm that has too many questionable securities under its current assets section, because it could indicate a failure of managerial competence or proper oversight. In the case of auction-rate securities, the failure rate was exceedingly high, and the use of auction-rate securities as a current asset significantly declined.

How Are Current Assets Used In Financial Analysis

Managers, analysts, and investors will look to a firm’s current assets position, especially in relation to current liabilities, in order to determine if the company has enough liquidity to meet its short-term obligations such as payroll and bills. Several liquidity ratios such as the quick ratio and current ratio can be used for this purpose .

Uses Of Current Assets

The total current assets figure is of prime importance to the company management with regard to the daily operations of a business. As payments toward bills and loans become due at the end of each month, management must be ready to spend the necessary cash. The dollar value represented by the total current assets figure reflects the companys cash and liquidity position and allows management to prepare for the necessary arrangements to continue business operations.

Additionally, creditors and investors keep a close eye on the current assets of a business to assess the value and risk involved in its operations. Many use a variety of liquidity ratios, which represent a class of financial metrics used to determine a debtor’s ability to pay off current debt obligations without raising external capital. Such commonly used ratios include current assets as a component of their calculations.

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How Are Cash And Cash Equivalents Reported On The Balance Sheet

Businesses can report these two categories of assets on the balance sheet separately or together, but most companies choose to report them together.

GAAP allows this financial statement presentation because some investments are so liquid and risk adverse that they are considered cash. Take T-bills for example. These investments are backed by the U.S. government and will always be paid. Its not like a private short-term bond or loan where the company can default or go bankrupt. T-bills are a safe, guaranteed investment that can be cashed in at any time. Thus, GAAP recognizes these investments as if they were actual currency.

If the T-bills cant be cashed in because of debt covenants or some other agreement, like in our debt restriction example above, the restricted T-bills must be reported in a separate investment account from the non-restricted T-bills on the balance sheet.

Impact Of Inventory On Cash Flow Statement


Inventory is the current asset, so it impacts on operating activity of the cash flow statement. The movement of inventory will cause cash inflow and outflow of the company.

Similar to other current assets, company needs to spend cash to acquire the inventory. So when the inventory increase, it means that company has to spend cash to purchase them. On the other hand, the decrease of inventory will make cash inflow as we have sold them.

We come up with the following rule:

  • Inventory increase => Cash Outflow
  • Inventory decrease => Cash Inflow

What if we purchase inventory on credit, so there is no cash flow. We may sell the inventory on credit, so cash not yet receive too. When we buy or sell inventory on credit, it will impact the Accounts Payable and Accounts Receivable balance. The movement of both accounts also present on the cash flow statement, so they will impact both sides.

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Function Of Cash Management

It is well acknowledged in financial reports and various studies that cash management is concerned with minimizing fruitless cash balances, investing temporarily excess cash usefully and to make the best possible arrangements for meeting planned and unexpected demands on the firm’s cash . Cash Management must have objective to reduce the required level of cash but minimize the risk of being unable to discharge claims against the company as they arise.There are five cash management functions:

  • Cash Planning: Experts emphases the wise planning of funds that can lead to huge success. For any management decision, planning is the primary requirement. According to theorists, “Planning is basically an intellectual process, a mental pre-disposition to do things in an orderly way, to think before acting and to act in the light of facts rather than of a guess.” Cash planning is a practise, which comprises of planning for and controlling of cash. It is a management process of predicting the future need of cash, its available resources and various uses for a specified period. Cash planning deals at length with formulation of necessary cash policies and procedures in order to perform business process constantly. A good cash planning aims at providing cash, not only for regular but also for irregular and abnormal requirements.
  • Objective Of Cash Management

  • To make Payment According to Payment Schedule: Firm needs cash to meet its routine expenses including wages, salary, taxes etc.
  • To minimise Cash Balance: The second objective of cash management is to reduce cash balance. Excessive amount of cash balance helps in quicker payments, but excessive cash may remain unused & reduces profitability of business. Contrarily, when cash available with firm is less, firm is unable to pay its liabilities in time. Therefore optimum level of cash should be maintained .
  • An effective management is considered to be important for the following reasons:

  • Cash management guarantees that the firm has sufficient cash during peak times for purchase and for other purposes.
  • Cash management supports to meet obligatory cash out flows when they fall due.
  • Cash management helps in planning capital expenditure projects.
  • Cash management helps to organize for outside financing at favourable terms and conditions, if necessary.
  • Cash management helps to allow the firm to take advantage of discount, special purchases and business opportunities.
  • Cash management helps to invest surplus cash for short or long-term periods to keep the idle funds fully employed.
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    The Cash Conversion Cycle

    The primary tool of working capital management is the cash conversion cycle , which calculates the time that money is tied up in the normal business cycle of the company. The CCC calculates the number of days that cash is tied up in inventory and accounts receivable, as well as the extent to which this cash investment is covered by the financing provided by a firms creditors through accounts payable. The CCC is calculated by adding the inventory conversion period, the number of days that work-in-process and finished goods sit in inventory, to the average collection period for accounts receivable. The sum of these two represents the total number of days that cash is tied up in nonearning assets.1

    Experienced businesspeople know that sales do not equal cash. It is quite possible that a business shows an accounting profit but has little or no cash due to sales waiting for collection in accounts receivable. Meanwhile, inventory needs to be purchased to continue the business cycle, which exacerbates the cash flow problem.

    As the firm purchases new inventory, financing is provided spontaneously through the use of accounts payable. As inventory purchases are made, trade credit is extended by suppliers and provides an automatic source of financing to the firm. There are two issues with accounts payable: the financing provided and the cost of that financing. The CCC focuses only on the former. We will discuss the cost of trade credit later in the chapter.

    Rajesh Kumar, in, 2014

    Accounts Payable Effect On Cash Flow

    Accounts Receivables Turnover Ratio – Meaning, Formula, Calculation & Interpretations

    When a company purchases supplies, it may not necessarily pay straight away. They may get an allowance of 30, 60, 90, or 120 days before the supplier requires payments. The purchaser records this short-term liability as accounts payable on the balance sheet.

    For the purchaser, that is akin to a source of cash as it increases cash flow and cash in hand.

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    Trade Receivables And Working Capital

    A companys trade receivables or accounts receivable is an important consideration when it comes to calculating working capital. Working capital is calculated as current assets minus current liabilities, with current assets including accounts receivable and inventory as well as cash and equivalents, and current liabilities including accounts payable.

    Where working capital is concerned, one significant metric is Days Sales Outstanding , which is defined as the time taken for a company to receive payment from customers after selling goods or services. A lower DSO is preferable, as the faster an invoice is paid, the sooner the seller can make use of cash.

    However, the other side of this equation is the buyer, who may wish to extend payment terms in order to increase their Days Payable Outstanding . This can result in a higher DSO for suppliers, which may not receive payment for 60 or 90 days in some cases.

    Working Capital Presentation In The Financial Statements

    Below we summarize the key takeaways weve described from the presentation of working capital on the financial statements:

  • While the textbook definition of working capital is current assets less current liabilities, finance professionals also refer to the subset of working capital tied to operating activities as simply working capital. Welcome to the magical world of finance jargon.
  • The balance sheet working capital items include both operating and nonoperating assets and liabilities whereas the changes in working capital section of the cash flow statement only includes operating assets and liabilities and
  • The cash flow statements informally named changes in working capital section will include some noncurrent assets and liabilities as long as they are associated with operations.
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    How Personal Guarantees Could Put Your Assets At Risk

    In order to open a business card or corporate card, many financial institutions require individuals to agree to something called a personal guarantee.

    A personal guarantee is a commitment to transfer ownership of ones personal assets to cover a debt . In other words, personal guarantees grant banks the right to seize an individuals assets to pay off business debts.

    Fortunately, you dont have to put your personal assets in jeopardy to build credit and win financing for your business. Brexs corporate card is tailored to the needs of startups and requires no personal guarantee. We base approval on the factors that matter, like cash on hand and monthly sales.

    Are Certificates Of Deposit Considered Included

    Answered: PRIOR COMPANY BALANCE SHEET Dec. 31,â¦

    Yes, CDs are short-term securities that are easily converted into a known amount of cash in a short period of time. Certificates of Deposit are always included in cash equivalents.

    Home » Accounting » Assets » Cash and Cash Equivalents

    Definition: Cash equivalents are short-term assets that are easily and readily converted into a know amount of cash. Cash equivalents usually include short-term investments in stock and other securities and treasury bills. Long-term investments can also be classified as cash equivalents if they are set to mature in the next 90 days or the maturity date is close enough that the fair market value and interest rate will not affect the value.

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    Differentiate Between Operating Investing And Financing Activities

    The statement of cash flows presents sources and uses of cash in three distinct categories: cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities. Financial statement users are able to assess a companys strategy and ability to generate a profit and stay in business by assessing how much a company relies on operating, investing, and financing activities to produce its cash flows.

    Assume you are the chief financial officer of T-Shirt Pros, a small business that makes custom-printed T-shirts. While reviewing the financial statements that were prepared by company accountants, you discover an error. During this period, the company had purchased a warehouse building, in exchange for a $200,000 note payable. The companys policy is to report noncash investing and financing activities in a separate statement, after the presentation of the statement of cash flows. This noncash investing and financing transaction was inadvertently included in both the financing section as a source of cash, and the investing section as a use of cash.

    T-Shirt Pros statement of cash flows, as it was prepared by the company accountants, reported the following for the period, and had no other capital expenditures.

    What Are Cash Equivalents

    Cash includes legal tender, bills, coins, checks received but not deposited, and checking and savings accounts. Cash equivalents are any short-term investment securities with maturity periods of 90 days or less. They include bank certificates of deposit, bankers acceptances, Treasury bills, commercial paper, and other money market instruments.

    Cash and its equivalents differ from other current assets like Marketable SecuritiesMarketable securities are unrestricted short-term financial instruments that are issued either for equity securities or for debt securities of a publicly listed company. The issuing company creates these instruments for the express purpose of raising funds to further finance business activities and expansion. and accounts receivableAccounts ReceivableAccounts Receivable represents the credit sales of a business, which have not yet been collected from its customers. Companies allow, based on their nature. However, certain marketable securities may classify as a cash equivalent, depending on the accounting policy of a company.

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    Merits Of Inventory Management

  • Inventory management guarantees adequate supply of materials and stores to minimize stock outs and shortages and avoid costly interruption in operations.
  • It keeps down investment in inventories, inventory carrying costs, and obsolescence losses to the minimum.
  • It eases purchasing economies throughout the measurement of requirements on the basis of recorded experience.
  • It removes duplication in ordering stock by centralizing the source from which purchase requisition emanate.
  • It allows better utilization of available stock by enabling inter-department transfers within a firm.
  • It offers a check against the loss of materials through carelessness or pilferage.
  • Perpetual inventory values provide a stable and reliable basis for preparing financial statements a better utilization.
  • Examples Of Current Assets

    Financial Management – Lecture 09

    When evaluating current assets, it can be helpful to consider an example to illustrate the details of a company’s current assets within a balance sheet. For this example, a fictional manufacturer will be used.

    Natural Green, a manufacturer of recycled and composite home products, has received its balance sheet for the year-long cycle. Its balance sheet includes three lines: assets, liabilities and shareholders equity. The assets section lists two types of assets: current assets and long-term assets. The current assets section details the following information for the company:

    Nature Green Balance Sheet

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    Cash Flows From Operating Activities

    Cash flows from operating activities arise from the activities a business uses to produce net income. For example, operating cash flows include cash sources from sales and cash used to purchase inventory and to pay for operating expenses such as salaries and utilities. Operating cash flows also include cash flows from interest and dividend revenue interest expense, and income tax.

    The Cash Flow Statement What Is It

    Also known as a Statement of Cash Flows, it is one of the main financial statements documenting the total amount of cash and cash equivalents your business received and used during a specified period.

    A Cash Flow Statement highlights changes in assets, equity, and liability, charting the total change in use of cash during the period. This reveals a business liquidity and helps analyze a companys operating activities.

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    What Is The Order Of Liquidity

    Order of liquidity is the presentation of assets in the balance sheet in the order of the amount of time it would usually take to convert them into cash. Thus, cash is always presented first, followed by , then accounts receivable, then inventory, and then fixed assets. Goodwill is listed last. The approximate amount of time required to convert each type of asset into cash is noted below:

  • Cash. No conversion is needed.

  • . A few days may be required to convert to cash in most cases.

  • Accounts receivable. Will convert to cash in accordance with the company’s normal , or can be converted to cash immediately by factoring the receivables.

  • Inventory. Could require multiple months to convert to cash, depending on turnover levels and the proportion of inventory items for which there is not a ready resale market. It may even be impossible to convert to cash without accepting a significant discount.

  • Fixed assets. Conversion to cash depends entirely on the presence of an active after-market for these items.

  • Goodwill. This can only be converted to cash upon the sale of the business for an adequate price, and so should be listed last.

  • The order of liquidity concept is not used for the revenues or expenses in the income statement, since the liquidity concept does not apply to them.

    In short, the order of liquidity concept results in a logical sort sequence for the assets listed in the balance sheet.


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