Current Asset in Balance Sheet

Definition of 'Current Assets'

1. A balance sheet account that represents the value of all assets that are reasonably expected to be converted into cash within one year in the normal course of business. Current assets include cash, accounts receivable, inventory, marketable securities, prepaid expenses and other liquid assets that can be readily converted to cash.   

2. In personal finance, current assets are all assets that a person can readily convert to cash to pay outstanding debts and cover liabilities without having to sell fixed assets. 

In the United Kingdom, current assets are also known as "current accounts."

Current Asset: A balance sheet item which equals the sum of cash and cash equivalents, accounts receivable, inventory, marketable securities, prepaid expenses, and other assets that could be converted to cash in less than one year. A company's creditors will often be interested in how much that company has in current assets, since these assets can be easily liquidated in case the company goes bankrupt. In addition, current assets are important to most companies as a source of funds for day-to-day operation

Investopedia explains 'Current Assets'

1. Current assets are important to businesses because they are the assets that are used to fund day-to-day operations and pay ongoing expenses. Depending on the nature of the business, current assets can range from barrels of crude oil, to baked goods, to foreign currency. 

2. In personal finance, current assets include cash on hand and in the bank, and marketable securities that are not tied up in long-term investments. In other words, current assets are anything of value that is highly liquid. 

FDR held as margin against Letter of Guarantee or Letter of Credit i.e.  LG or LC

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Are they treated as current asset for computing permissible bank finance?

If yes why?

What is logic and what are rules behind such rationale?

If no?

Why banks are still treating FDR held as margin against LC or LG as current asset knowing very well that these FDR, though in nature encashable anytime as per bank’s whims and fancies, these FDRs cannot be utilized as working fund for business operation.

And when these FDR cannot be and has not been used by the company in practice for business operation during last 12 months, why bankers prefer treating these FDR as current asset?

As a matter of fact wrong concept of treating these FDR as current asset enhances the amount of ‘maximum permissible bank finance,and as a result of which  the businessmen always feel money crisis and ask for excess over the limit. In most of the cases it is found that the company has left with no working fund, Net working capital goes negative as soon as the FDRs held as margin against LG or LC are treated as non-current asset.

The prime reason for many cash credit accounts of large corporate borrowers turning bad and this is the key reason why such companies are going for restructuring.

If one peep into the balance sheet of these companies it will be found that such companies has exhausted entire working capital in these apparently short term FDRs.

Instead of demanding infusion of fresh capital from these borrowers, bankers under pressure to achieve credit target prefer ignore the basic principles of computation of permissible bank finance and take the risk of inviting fresh Non Performing Assets in their bank.

Are such FDR (held as margin against LG or LC) fit for computation of current asset for calculating current ratio?

If yes why?

Why FDR held as margin against LG or LC are treated differently, yes as current asset for current ratio and not as Current asset for computing Net working capital and MPBF?

WORKING CAPITAL MANAGEMENT

(Part-1)

Introduction: Why a business need working capital

Any enterprise whether industrial, trading, or others generate three types of assets to run

its business as a going concern. 

1. Fixed assets to carry on the production/ business such as land, building, plant & machinery, furniture & fixtures etc. For going concern these are of permanent in nature and are not to be sold except in adverse conditions.

2. Current assets require for day to day  working of the business/unit which are floating in nature and keep changing during the course of business at a rapid pace in comparison to the other assets. These are short term in nature such as inventory, receivables (outstanding less than six months), loan & advances, cash

& bank balance etc.

3. Non- Current assets which are neither fixed assets nor current assets such as Intangible assets, long term investments,  FDR put in bank as margin money,security deposit (rent, government authorities etc), debtors outstanding more than

six months

Further fixed assets are to be financed by owned funds and long term liabilities raised by

a concern while current assets  are partly financed long term liabilities and partly by

current liabilities and other short term loans arranged by concern from the bank. 

Nature of industry decides the requirement of concern about the investment in current

assets. For example big industrial projects  may require substantial investment both in

fixed and current assets in comparison to trading unit or service sector. A trading unit

needs to invest a huge amount in stock-in-trade in comparison to fixed assets.  

Bank assessment of working capital

Reserve Bank of India had instructed to use strictly and adhere with the “second method

of lending” to banks while lending for working capital. 

As per this method the borrower should finance 25% of all current assets from owned

funds and long term liabilities and the balance be financed by bank. By applying this

method of lending one need to calculate the Maximum Permissible Bank Finance

(MPBF) for deriving the maximum limit which the bank could extend to the borrower. 

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