Updated July 18, 2023
Definition of Short-Term Assets
Short-term assets, also known as current assets, are assets of the company that generate revenue within a year. These assets are highly liquid, meaning they can be easily converted into cash or sold in the market to obtain money within one year.
Explanation
Short-term assets are those the company expects to sell in the market to convert into cash within a period of 1 year. These assets also referred to as current assets, are displayed on the assets side of the balance sheet as the company’s current assets.
Current assets include stock/inventory, cash and cash equivalents, trade receivables, short-term deposits, marketable securities, prepaid expenses, etc. Moreover, these assets are important for the business to earn money in the normal course of business i.e. they are the main source of income. Generally, in the trading business, short-term assets are majorly used.
Examples of Short-Term Assets
Various examples of short-term assets are:
- Cash & Cash Equivalents: Cash & Cash equivalents include cash balance, bank balance, fixed deposits, etc.
- Trade Receivables: Trade receivables include the amount that is owed to the company by the outsider. They are the company’s debtors who have purchased its goods on credit and are yet to pay the company.
- Short-Term Deposits: These deposits are security deposits with the government authorities like the Electricity Department Etc. and Are Recorded as Current Assets of The Company.
- Prepaid Expenses: Prepaid expenses refer to the expenses paid in advance by the company, but the benefits from such cash outflows will be received in the future. For example, salary paid in advance, etc.
Example
Let’s look at the practical example of a short-term asset:
Mr. Nick started trading curtains by bringing capital $500,000 in the bank account from which he purchased an office building that cost him $ 63,000. He also purchased furniture for $25,000. The inventory purchased of $15,000 was purchased by him. Also, during an accounting year, he sold inventory that cost him $2,500 for cash and inventory costing $3,500 for credit. So we need to calculate the short-term assets of the business at the end of the period.
Solution:
From the above transactions, office buildings and furniture are long-term assets, so they are not to be calculated as they are not included in short-term assets.
Calculation of short-term assets:
- Cash: cash received was $2,500 from the sale of inventory. Therefore cash is $2,500 at the end.
- Bank: the bank balance should be $500,000 less $63,000 (cost of building) less $25,000(furniture) less $15,000 (inventory), which is equal to $397,000.
- The inventory balance is $15,000 minus $2,500 minus $3,500, which equals $9,000.
- Trade receivable is $3,500.
Therefore, total short-term assets = $2,500+$397,000+$9,000+$3,500 = $412,000.
Short-Term Assets vs Long Term Assets
Following are the major differences between short-term and long-term assets.
- Long-term assets are used for a long duration, i.e., more than a year in the business, to generate revenue. In contrast, short-term assets are those used for less than a year and generate revenue/income within one year.
- The long-term assets are not readily converted into cash as they are used for several years, so they are not used to meet the business’s short-term operational requirements. In contrast, short-term assets are used to meet the business’s short-term operational requirements as these assets are readily converted into cash.
- The depreciation is charged on Long-term assets, dividing the cost of such assets by booking it as an expense over the period of its useful life. In contrast, no such depreciation is charged on the short-term assets of the business.
- On the sale of long-term assets, the capital gain and loss earned and incurred, respectively, are referred to as long-term capital gain/l loss, whereas on the sale of short-term assets, the gain/loss incurred is referred to as short-term capital gain/loss.
Advantages of Short-Term Assets
The advantages of short terms assets are:
- The short-term assets are the company’s most liquid assets, so they are an essential part of the business because they are available to meet short-term requirements.
- The cost of funding the company’s short-term assets is low compared to the long-term assets, and the loans to purchase short-term assets are faster to obtain.
- If the short-term assets are more in the company, it shows that its liquidity position is very high.
- Also, the amount of current assets is used to do the ratio analysis as the figure is used to calculate various liquidity ratios such as current ratio, quick ratio, etc. so that the company’s liquidity position can be measured.
Disadvantages of Short-Term Assets
The advantages of short terms assets are:
- Sometimes the large portion of the current assets in the business indicates that the company’s financial position is not good.
- If the current assets are too much, it also reflects that short-term assets are stuck and are unable to get realized into cash which can result in the loss of market share of the business.
Conclusion
Thus, Short term assets are highly liquid as they are readily convertible into cash. These assets are helpful in the company’s working capital management as the funds are arranged from these short-term assets to meet the day-to-day requirement of the business. These assets include cash balance, bank balance, inventory, and other assets that can generate revenue within a period of one year.
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