Current Assets and Current Liabilities: The Financial Statement Secrets Every Investor Must Know

Why Must Investors Pay Attention to These Two Indicators?

Understanding financial statements is a fundamental skill for value investors, among which the most easily overlooked are the two counterbalancing metrics in the balance sheet: Current Assets and Current Liabilities. These figures not only show whether a company can weather tough times but also reveal the company’s true operational quality.

When a financial storm hits or the market suddenly shifts, companies with sufficient current assets can respond calmly; conversely, firms under excessive pressure from current liabilities may fall into trouble. Therefore, compared to the grand narrative of long-term assets, the ratio of current assets to current liabilities often serves as a direct window into a company’s short-term survival capability.

What Do Current Assets Really Represent?

Current Assets refer to the portion of a company’s assets that can be converted into cash within 12 months. They directly reflect the company’s short-term debt-paying ability and operational flexibility. In contrast, Current Liabilities are debts that need to be settled within 12 months.

The core differences are:

• Current Assets: Strong cash convertibility—more is better? Not necessarily.
• Current Liabilities: Less debt pressure equals more security, but also reflects financing costs.

The quality of current assets varies greatly. Cash and bank deposits convert the fastest, but accounts receivable that cannot be collected and accumulated inventory become “paper assets.”

What Are the Specific Components of Current Assets?

Cash and Cash Equivalents

This is the most liquid asset. Includes account cash, checks, bank deposits. The advantage is zero risk; the downside is no return. Holding too much cash may indicate weak investment ability or a lack of good investment opportunities.

Short-term Investments and Marketable Securities

To generate returns on idle funds, companies may purchase stocks, bonds, or gold short-term. These assets can be quickly liquidated, but carry price fluctuation risks. During market downturns, these “paper wealth” can shrink significantly.

Accounts Receivable and Notes Receivable

This part comes from sales made on credit. Companies extend credit to customers to boost sales, expecting to receive cash later. Sounds good, but if customers go bankrupt or the market declines, this money may never be recovered.

Inventory and Goods

This is the most problematic asset. Excess raw materials, work-in-progress, and finished goods tie up large amounts of capital. If products cannot be sold or become obsolete, inventory turns into “zombie assets,” possibly requiring impairment, further dragging down profits.

Prepaid Expenses and Other Current Assets

Includes expenses paid in advance but not yet realized, such as prepaid rent, insurance, etc. These usually constitute a small proportion but still require attention.

Where Does the Pressure from Current Liabilities Come From?

A company’s current liabilities include:

• Accounts Payable: Debts owed to suppliers
• Short-term Borrowings: Loans due within 1 year
• Notes Payable: Promised debt via notes
• Unearned Revenue: Customer payments received before delivery
• Wages and Taxes Payable: The most urgent expenses

The key is to look at the Current Ratio: Current Assets ÷ Current Liabilities. A higher ratio indicates less debt repayment pressure, but too high (e.g., over 3) may suggest low asset efficiency.

How to Assess a Company’s True Health from Financial Statements?

Take Apple Inc. as an example. At the end of 2019, its current assets reached $162.8 billion, with $59 billion in cash and cash equivalents. It seemed sufficient, but by the end of the 2020 fiscal year, the situation changed interestingly:

• Current assets decreased from $143 billion to $135 billion
• Cash and cash equivalents plummeted from $90 billion to $48 billion (a 46% drop)
• Accounts receivable surged from $37 billion to $60 billion (a 62.7% increase)

What does this indicate? Apple changed its collection strategy, possibly to boost sales by relaxing credit policies, or it reflects longer collection cycles in certain sales channels. This signal warrants in-depth tracking by investors to determine whether it’s a strategic adjustment or a warning sign of deteriorating operations.

Ranking the Quality of Different Types of Current Assets

When a company faces a crisis, the speed at which assets can be liquidated determines survival. Investors should evaluate assets in the following priority:

1. Cash → The most stable, risk-free
2. Bank Deposits and Short-term Deposits → Nearly equivalent to cash
3. Marketable Securities and Short-term Investments → Usually quickly liquidated
4. Accounts Receivable → Increasing risk, depending on customer creditworthiness
5. Prepaid Expenses → Difficult to convert into cash
6. Inventory → The most easily devalued asset

How Should Investors Read This Data?

First, don’t just look at the absolute value of current assets; focus on their composition. A high proportion of cash indicates a conservative company; high proportions of accounts receivable and inventory may suggest operational pressures.

Second, track trends. If accounts receivable keep growing without corresponding sales growth, it’s a warning sign. If inventory increases year after year while sales decline, it indicates products aren’t selling.

Finally, calculate Current Ratio and Quick Ratio:

• Current Ratio = Current Assets ÷ Current Liabilities (Ideal range: 1.5-2.5)
• Quick Ratio = (Current Assets - Inventory) ÷ Current Liabilities (Ideal range: 1-1.5)

The quick ratio is more stringent, excluding the hardest-to-liquidate inventory, providing a more accurate reflection of a company’s emergency capacity.

Summary

Current assets and current liabilities are the most direct indicators of a company’s life or death in financial reports. They not only show whether a company can survive short-term crises but also expose operational quality issues.

Don’t be fooled by absolute numbers—if a company’s current assets are mostly unsellable inventory and uncollectible receivables, they are essentially useless. Conversely, companies with high cash proportions, good receivables quality, and fast inventory turnover are the real “tough guys” against risks.

Next time you read a financial report, start by examining current assets and current liabilities, and understand the company’s true health from this “short-term perspective.”