Measuring Current Assets

saupload inventory2The relative size of current assets differ significantly across companies in different industries.  Current assets as a percentage of total assets varies from industry to industry.  Current assets vary from an average of 32 percent in the telephone communications industry to to over 80% for certain retailers and security brokers.  For example, the current assets of MCI, a member of the telephone communications industry, are only 29% of total assets, while the ratio of current to total assets for Merrill Lynch, a security broker, is approximately 80 percent.  Why do these vary?  When you learn how to become a CPA, taking into account inventory on-hand and interpreting how the inventory is measured is an important requirement.

These variations are large because each company’s operations are very different.  Retailers carry large amounts of inventory and receivables, especially if they provide their own credit cards (e.g., J.C. Penny).  Security brokers (e.g., Salomon Brothers) hold large amounts of cash and receivables and invest highly in short-term securities, while automobile manufacturers (e.g., General Motors) carry significant inventories.  On the other hand, the primary investment for eating places (e.g., McDonald’s) and telephone communications companies (e.g., AT&T) is in property, plant and equipment.  So…..accounting for and managing current assets, while important for all industries, is especially important for retailers, financial services, and certain manufacturers.

The distinction between current and noncurrent assets is useful because it provides an easy-to-determine, low-cost measure of a company’s ability to produce cash in the short-term.  Current assets are often compared to current liabilities (the liabilities expected to require cash payments withing the same time period as current assets) as an indicator of a company’s solvency position.  Reasoning that current liabilities are a measure of short term cash outflows, these comparisons appear to be logical.  Three such comparisons are working capital and two solvency ratios, the current ratio and the quick ratio.  Working capital is defined as current assets less current liabilities; the current ratio is equal to current assets divided by current liabilities; and the quick ratio divides cash plus short-term investments plus short-term receivables by current liabilities.