Current Assets are those assets which are converted into cash in one operating cycle in the process of manufacture. Raw materials are purchased with cash and expenses are incurred in converting the raw materials into stock in process; when the processing is over, the stock in process becomes finished goods.
When the finished goods are sold on cash basis, they are converted directly into cash and if they are sold on credit terms, the finished goods are replaced by debtors which will be converted into cash on realization. This process is called production cycle or working capital cycle or operating cycle.
By convention, all assets which are used up in the production process in the normal course or get converted into cash within a year from date of the balance sheet, are classified as current assets. Cash and bank balances are part of current assets.
Investments in govt. securities / bonds, bank deposit etc., are classified as current assets if they are unencumbered and liquid enough to be sold or against which a loan can be raised. However, if the investment has been made in associate firm, distributor firm etc., with the intention of holding a stake in the other firm, the investment would be treated as miscellaneous asset.
Similarly, if an investment has been made in a security which has been offered as collateral to other creditors, it will be treated as miscellaneous asset. The criterion to determine whether an investment is current or not, is the intention behind the investment and the liquidity of the investment.
Inventory held for normal production will be current asset. Stagnant stocks have to be identified and treated as miscellaneous assets, as these stocks are not consumed in the ordinary course of production. Similarly, any goods returned by the purchaser for defects, obsolete stocks etc., should be reduced from the current assets.
It is necessary for a financing bank to ascertain the methodology of how the valuation of stocks has been carried out by the unit. Stocks are valued at the cost price or market price, whichever is lower. It has to be ensured that stock-values are not manipulated.
4. Sundry Debtors
Book Debts: Book Debt is the aggregate credit sale pending realization.
Bills Receivables: Bills Receivables represent sales made by the firm to its customers.
5. Other Current Assets
Prepaid expenses, advance tax paid etc., are classified under current assets.
6. Fixed Assets
These are assets that have long commercial life and are employed by the firm for its operations. Fixed assets are classified as Block Assets and Sundry Assets. Block assets are land, building, plant and machinery and such other assets which aid the production process but are not consumed in the production process. They undergo normal wear and tear, which is called depreciation.
Sundry items such as furniture and fittings, fixtures, office equipment, loose tools etc.. are classified as sundry assets. They are generally of low value comparatively. The Block Assets are usually the security available to the term lender.
7. Miscellaneous Assets
Miscellaneous Assets are those assets which are neither current nor fixed or intangible assets. Advances to employees, investment in associate firms/ associates, unquoted shares, stores and spare-parts etc., are treated as miscellaneous assets.
Consumable Stores and Spares: They are absorbed in the production. Generally, it is a small portion of the inventory, In some industries, the value of consumable stores and spares would be significant.
8. Intangible Assets
These assets have no physical form and denote goodwill, copy right, trade-marks, design, patent, royalties, licenses, Leaseholds, etc. They are included in the balance sheet when certain amounts have been spent thereon which should be written off against future profits. Intangible assets are of value only when the unit is a going concern.
Types of Liabilities
1. Current Liabilities
These are short term obligations generally due and payable within one year from the date of the balance sheet. These represent sources which are short term in nature and are employed for financing current assets.
Short Term Bank borrowings (Cash credit, overdraft etc.)
Advance payments received from customers
Term loan installments due within one year.
2. Deferred Liabilities
These are long term liabilities. They represent the long term finance. Any item which matures for payment after a period of one year from the date of the balance sheet is called term/deferred liability. Deferred liabilities are incurred to acquire fixed assets, such as land, building, plant & machinery, equipment, etc. and repaid over a period of time.
Deferred Liabilities normally consist of Term Loans from banks, Debentures, Deferred credit from suppliers of capital equipment /materials, Deposits from public (repayable beyond one year) and other term liabilities such as provision for gratuity liabilities.
3. Net worth (NW)
Net worth indicates shareholder’s funds or owner’s equity. It is represented by capital, reserves and surplus. This is a source of permanent nature to the company and does not constitute any outside liability. The total of all intangible assets are deducted from the net worth in order to arrive at the tangible net worth.
4. Reserves and Surplus
Capital and Revenue Reserves: There are two types of reserves.
Capital reserves arise on account of revaluation of fixed assets, issue of shares at a premium, profits on account of sale of assets, capital subsides received from Central / State Government etc.
Revenue reserves are created out of profits earned from operations. A reserve created to meet any unforeseen contingency is called General Reserve and reserve created for some definite purpose is called a specific reserve.