Simply stated, accounts receivables
are the amounts owed to you and are evidenced on your balance sheet by promissory
notes. Accounts receivable are the amounts billed to your customers and owed
to you on the balance sheet’s date. You should label all other accounts receivable
appropriately and show them apart from the accounts receivable arising in the
course order of liquidity of current assets of trade. If these other amounts are currently collectible, they may
be classified as current assets. These investments are temporary and
are made from excess funds that you do not immediately need to conduct operations. You should make
these investments in securities that can be converted into cash easily; usually
short-term government obligations.
Although your intangibles lack physical substance,
they still hold value for your company. Sometimes the rights, privileges and
advantages of your business are worth more than all other assets combined. These
valuable assets include items such as patents, franchises, organization expenses
and goodwill expenses. For example, in order to become incorporated you must
incur legal costs.
The Current Ratio
Now, Insurance Company B also has to pay out $40 million in insurance claims over the next three months, however, it has cash and cash equivalents valued at only $25 million. If a business makes sales by offering longer credit terms to its customers, some of its receivables may not be included in the Current Assets account. Market liquidity is critical if investors want to be able to get in and out of investments easily and smoothly with no delays. As a result, you have to be sure to monitor the liquidity of a stock, mutual fund, security or financial market before entering a position. Some of these may include prepaid expenses that haven’t been used up yet, such as advertising and insurance, the amount of a business sale price above its tangible assets, called goodwill, and land improvements.
For example, if Company B has $800,000 in quick assets and current liabilities of $600,000, its quick ratio would be 1.33. Current assets are used to finance the day-to-day operations of a company. This includes salaries, inventory purchases, rent, and other operational expenses. But unless the financial system is in a credit crunch, a company-specific liquidity crisis can be resolved relatively easily with a liquidity injection (as long as the company is solvent). This is because the company can pledge some assets if it is required to raise cash to tide over the liquidity squeeze. This route may not be available for a company that is technically insolvent because a liquidity crisis would exacerbate its financial situation and force it into bankruptcy.
Understanding Financial Liquidity
Other investment assets that take longer to convert to cash might include preferred or restricted shares, which usually have covenants dictating how and when they can be sold. In addition, specific types of investments may not have robust markets or a large group of interested investors to acquire the investment. Consider private shares of stock that cannot easily be exchanged by logging into your online brokerage account. Assets like stocks and bonds are very liquid since they can be converted to cash within days. However, large assets such as property, plant, and equipment are not as easily converted to cash.
Investments
include stocks or the bonds you may hold for another company, real estate or
mortgages that you are holding for income-producing purposes. Your investments
also include money that you may be holding for a pension fund. How quickly a current asset account can convert into cash can change depending on the company and the industry. However, there are accounts that have pretty standard turnaround times for cash conversion. Using the order of liquidity to present the current assets has many benefits, not only for the readers of financial statements but for management of the company as well.
