Understanding Current Assets on the Balance Sheet

Current Assets on a balance sheets shows a company's cash and cash equivalents
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When you look at a company's balance sheet, you'll see three categories: assets, liabilities, and owners' equity. The first section listed under the asset section of the balance sheet is called current assets. 

Current assets on the balance sheet include cash, cash equivalents, short-term investments, and other assets that can be quickly converted to cash—within 12 months or less. Because these assets are easily turned into cash, they are sometimes referred to as liquid assets. 

Cash and Cash Equivalents

Cash and Cash Equivalents under the current assets section of a balance sheet represents the amount of money the company has in the bank, whether in the form of cash, savings bonds, certificates of deposit, or money invested in money market funds. It tells you how much money is available to the business immediately.

So what is the proper amount of cash a company should keep on its balance sheet? Generally speaking, the more cash on hand the better, although excessive amounts are likely to make investors unhappy, as they would rather have the money paid out in the form of a dividend to be reinvested, spent, saved, or given to charity.

Short-Term Investments

These are investments that a company plans to sell quickly or can be sold to provide cash.

Short-term investments aren't as readily available as money in a checking account but they provide added cushion if some immediate need were to arise.

Such securities and assets become important when a company has so much cash sitting around that it has no qualms about tying some of it up in slightly longer-term investment vehicles, such as bonds, that have maturities of less than one year. This allows the business to earn a higher interest rate than if it stuck the cash in a corporate savings account.

Accounts Receivable

A company's accounts receivable is the outstanding money owed to it in the short-term from customers or clients. It's counted under current assets because it is money the company can rightfully collect, having loaned it to clients as credit, in one year or less.

Inventory

Inventory is another type of current asset; it refers to the goods or raw materials a company has on hand that it can sell or use to produce products for sale. Then those products are sold, which produces revenue.

Cash-on-Hand and Dividends

A decent amount of cash-on-hand gives management the ability to pay dividends and repurchase shares, but more importantly, it can provide extra wiggle room if the company runs into any financial difficulties.

Typically, a common stock investor is going to be happiest when the stock market heads down if she owns a large, profitable business with enormous cash reserves and little to no debt. Such a strongly capitalized business can take advantage of a tough financial climate to buy up competitors for a fraction of their true value.

Examples of Cash-Heavy Companies

A company with ample capital under its current assets is said to have a "fortress balance sheet." One such example is Warren Buffet's holding company, Berkshire Hathaway, which had a stockpile of more than $120 billion in cash by the end of 2019.

Another example of a company with tons of cash is Japanese video game company Nintendo, which has so much cash parked in its current assets ($5 billion) that even if it stopped selling products tomorrow, it could continue to pay its bills for years. Perhaps Nintendo has fortified itself with cash because memories of the 1980s crash of the video-game industry are still fresh. During that time, video-game companies lost hundreds of millions of dollars and laid off thousands of employees as demand dropped and sales plummeted.

Borrowing for Balance Sheet Cash

There are some cases where cash on the balance sheet isn't necessarily a good thing. When a company is not able to generate enough profits, it may borrow money from the bank, which means the money sitting on its balance sheet as cash is actually debt. To find out, you will have to look at the amount of debt the company has, which is shown in its balance sheet liabilities section.

You probably won't be able to tell if a company is weak based on its cash balance alone. The amount of cash relative to debt payments, maturities, and cash flow needs is far more telling.

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 these instruments could dry up and it could take weeks or months—or even longer—to 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.

Article Sources

  1. Berkshire Hathaway. "Form 10-Q." Accessed Jan. 28, 2020.

  2. Nintendo. "Financial Highlights." Accessed Jan. 28, 2020.

  3. The New York Times. "Video Games Industry Comes Down to Earth." Accessed Jan. 28, 2020.

  4. FINRA. "FINRA Issues Guidance to Investors Caught in ARS Auction Failures." Accessed Jan. 29, 2020.