X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2019 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Current assets - what are they? - Views on News from Equitymaster

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Current assets - what are they?

Aug 27, 2009

In the previous article of this series, we discussed one of the components of the 'Application of funds' side of the balance sheet - Fixed assets. In this article we shall take a look at another component - current assets. As compared to fixed assets, which are relatively more difficult to liquidate, current assets are easier to convert into cash. The reason why fixed assets are less liquid in nature is because of their influence on a company. The usage of current assets on a company is more short term in nature (usually a period of one year) as against that of a fixed asset. Current assets are assets that are used to fund day to day operations and pay ongoing expenses of a company.

The most common current assets include sundry debtors, inventories, cash and bank balances, loans and advances, amongst others. We shall briefly discuss some of the key current assets one by one.

What are inventories?
Inventories are goods that are in different stages of production and have not yet been sold. As such, they could be finished or semi-finished products. As you may be already aware, goods when manufactured go through various processes - from being a raw material to a semi-finished good (work-in-progress) to a finished good. Inventories would also include packaging material. Many a times, you may also find an entry such as good-in-transit under inventories. These are goods that have departed from the dispatch point but have not yet arrived at the delivery point.

An interesting tool that would help understand and analyse the inventory position of a company is 'Inventory turnover'.

Inventory turnover is calculated by dividing the sales by the inventory of a particular period (usually a year).

As such, Inventory turnover = Net sales/ inventory

Let us explain this with the help of an example. FMCG major Nestle had inventories worth Rs 4.4 bn at the end of CY08, i.e. 31st December 2007. The company reported a topline (net sales) of Rs 42.2 bn. As such, the company had an inventory turnover of 9.6 times. This means that, the company will be able to sell the current level of inventory nearly 9.6 times each year. The higher the inventory turnover ratio, the better it is for a company.

Let us take an example. Suppose company XYZ reported a topline of Rs 5 bn and had an inventory of Rs 15 bn. This means that if company XYZ maintains the level of inventory throughout the year, it will take nearly three years to clear the inventory level it currently has. This indirectly indicates that the inventory management has been poor as the company's management has locked in a lot of funds towards inventories.

It may be noted that one could also calculate inventory turnover by dividing the inventory by the cost of goods sold (COGS) during the year. The reason we can calculate it with COGS is because the inventories are valued at cost and not on sale prices.

Another popular metric that is used is that of 'inventory days'. This is calculated as follows:

Inventory days = 365/ Inventory turnover

or

Inventory days = 365/ (Sales/inventory)

As such, Inventory days = Inventory/Sales *365

While inventory turnover measures the number of times (on an average) the inventory is sold during the period, inventory days is a ratio which indicates the number of days it takes a company to sell its inventory. That is the reason for the division of 365/inventory turnover.

Before we move on to the next current asset, we would like to mention that it would only make sense for one to compare this parameter between companies that are present in the same or similar businesses.

What are sundry debtors?
In simple terms, debtors are persons who owe money to the company. Typically, such debts are on goods and services that are sold on credit. Sundry debtors can also be termed as 'accounts receivable'. The reason sundry debtors are recorded as assets to a company is because the money belongs to the company, which it expects to receive within a short period.

From an investor's perspective, it would help to analyse the speed at which a company is able to collect the money from its debtors. If a company's collection period is long or is expanding, it is not a good sign. Apart from meeting daily expenses, a company would also prefer having low debtor days (mentioned below) to avoid the risk of defaults.

Similar to inventory days, there is a ratio which helps in analysing the number of days it takes a company to collect payments from its debtors. This ratio is termed as 'debtor days'. The formula for the same is:

Debtor days = Debtors/Sales * 365

Let us take up an example to understand this further. At the end of CY08, sundry debtors on Nestle's books stood at Rs 455.9 m. The company had reported net sales of Rs 43,242.5 m. As such, by using the above formula, the outcome is 3.8 days. This means that the company is able to collect its payments within an average period of 3.8 days, which is a very low period.

Let's compare this to an engineering company such as Punj Lloyd. At the end of FY09, the receivables on the company's books stood at Rs 26.7 bn, while it reported a topline (net sales) of Rs 119.1 bn. As such, the company had average receivable days of 81.8 days during the year.

We would like to reiterate that these figures (inventory days and debtor days) should be compared to companies within a particular sector. Comparing companies across industries would throw up different numbers, purely due to the nature of the respective businesses.

What are cash and cash equivalents?
As you may be aware, cash and cash equivalents are the most liquid assets found in any company's balance sheet. As an investor, you must have heard experts recommend investing in cash rich companies (especially in recent times). Why would this be the case? This is simply because it would allow companies to meet expenses in a downturn when the business is slow.

Cash does not only offer protection against difficult times, but also gives companies more options for future growth. Companies could grow by acquiring companies. If they do not find a company that meets their criteria, they could pay their shareholders through dividends.

However, a big cash balance is not always a good sign. What would be an optimum cash balance that a company must have depends from sector to sector. Sometimes, it differs between companies within a particular sector.
One could analyse cash levels as a percentage of sales. We ran a query on CMIE Prowess to study some of these figures between companies that form part of the BSE-IT and BSE-FMCG indices.

During the last five years, the average cash balance as a percentage of sales (standalone figures) stood at about 4% for companies that form part of the BSE-FMCG Index. On comparing the same parameter on companies that form part of the BSE-IT Index, the figure stood at an average of 24%.

For instance, during the period between CY99 to CY04, Nestle maintained cash to sales average of 0.4%. During the last four years it has increased to an average of 2.4%. During CY08, the company's cash balance stood at 4.5% of its full year net sales.

What are loans and advances?
Loans and advances include various items such as advance to suppliers and vendors (in accounting terminology it is known as 'advances recoverable'), advance tax payments (income tax, wealth and fringe benefit tax), loans to employees, deposits, balance with customs, amongst others.

In the next article, we shall take a look at current liabilities and also briefly glance through the topic of working capital.

Investing: Back to Basics Article Series - Previous article | Investing: Back to Basics Article Series | Next article


Equitymaster requests your view! Post a comment on "Current assets - what are they?". Click here!

2 Responses to "Current assets - what are they?"

Deb

Sep 1, 2009

Dear K D Vartik The last line of the article gives
link to previous articles. The link Investing back to
basics

Like 

K.D.Vartak

Aug 30, 2009

The article is very useful to a layman like me. Please let me know if I can access the previous articles in the series, Thanks. I have sent you this request a few days ago but you have not responded, Thanks

Like 
  
Equitymaster requests your view! Post a comment on "Current assets - what are they?". Click here!

More Views on News

Do You Know Lesser Known Funds Can Earn BIG Returns? (Outside View)

Jun 14, 2019

PersonalFn explains about how can one add lesser known funds to their portfolio to earn big gains.

Why I Believe Smallcaps Will Catch up to the Sensex (Profit Hunter)

Jun 14, 2019

Smallcaps have gone nowhere even as the Sensex makes new all-time highs. Find out why Richa believes this a good opportunity to invest in smallcaps.

Why Patience Is the Key to Successful Investing (Outside View)

Jun 14, 2019

PersonalFN explains how you will be rewarded if you are patient with your investment.

Lessons in Investing Fraud from a Movie Theatre (Fast Profits Daily)

Jun 14, 2019

Real life lessons in investment frauds.

The Growing NBFC Crisis: Here's How You Can Profit from It (The 5 Minute Wrapup)

Jun 14, 2019

The DHFL saga only highlights the fact that the NBFC crisis won't go away anytime soon...but you can still profit from it.

More Views on News

Most Popular

The Best 4 Small-cap Stocks to Buy(The 5 Minute Wrapup)

Jun 3, 2019

In the sometimes good sometimes bad market of small caps, there are strong buying opportunities available today. But this great opportunity won't last forever.

The Great Indian NBFC Bubble Has Burst but I Will Still Recommend These Safe NBFCs(The 5 Minute Wrapup)

Jun 11, 2019

One chart that predicted the NBFC crisis back in 2016.

7 Stocks That Will Remain Evergreen in this Era of Technological Disruption(The 5 Minute Wrapup)

Jun 13, 2019

We are living in an era of disruption. Are your stocks well equipped to adapt to changes that disruption will bring along?

The Top 7 Stocks to Profit from Modi's Repeat Performance(Profit Hunter)

Jun 3, 2019

The long-term India story looks promising with the Modi government back in power. Which stocks are likely to go up the most?

Just One Stock Made Buffett Billions - And Can Make You Crores(Profit Hunter)

Jun 6, 2019

Coca Cola is arguably one of Warren Buffet's best stock picks. But did you know that small investors picked up the stock five decades before Buffet? Read on...

More

Get the Indian Stock Market's
Most Profitable Ideas

How To Beat Sensex Guide 2019
Get our special report, How to Beat Sensex Nearly 3X Now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Jun 14, 2019 (Close)

MARKET STATS