The current assets are short term assets that can be converted to cash readily within 12 months. The current assets consists of cash, marketable securities, accounts receivables and inventory.
If the current assets in the company are greater than the current liabilities, it signifies that the company is able to pay off any short term obligations. These short term obligations are reflected the the company’s current liabilities.
One of most important items on the current assets is cash. A company without cash may cease to be a going concern going forward. At times, an abundant cash tells an investor or a trader that the company is doing a good job managing the business. As an example, company A is debt free and has a market capitalisation of 30 million. On its balance sheet, the company has 40 million of cash and cash equivalents and is earning an average net income of 5 million a year. This is an example where a company may be considered undervalued. This is because private investors could buyout the company as it has cash resources exceeding the market capitalization of the company. So private equity players may take a loan and make an offer for 35 million for the entire company, and after the acquisition has been completed, use the company’s cash resources to pay off its $35 million loan. After which, the private investors are free to enjoy whatever cash flows the business can produce.
Of course this is an oversimplified example but scenarios like this do occur quite frequently in the market. The current assets should be studies with the current liabilities and the balance sheet as a whole to come to a conclusion that a company is financially healthy. Looking at the current liabilities alone is not enough.
The current ratio is the ratio of current assets to current liabilities. An investor would want the current ratio to be healthy so that the company can easily pay off its current obligations. As a rule, only invest in companies with a current ratio of 2 or more and consider other factors as well.
Read : Current Liabilities