Net current assets, or working capital, are a reflection of a company’s short-term health and can include cash, inventory, and accounts receivable. If liabilities exceed assets for an extended period, it could lead to bankruptcy. Stocks trading below net current asset value could be good investments.
There are several ways to value a company and determine if it is likely to be a good investment. In accounting, there is a formula for current assets that is an indicator of the financial condition of a company. The term “net current assets” refers to the value of the company’s total current assets after all of its current liabilities have been subtracted. These are tangible assets that can include cash, inventory, and accounts receivable, which is money owed to a business. Also known as working capital, net current assets are a reflection of the short-term health of the company on a balance sheet, which is a financial statement filed with the regulatory body in a region.
If net current assets are sufficient to pay current liabilities, there is a positive working capital ratio. In the event that assets are insufficient to meet short-term debt obligations, creditors will not be paid and there will be negative working capital. If liabilities continue to exceed assets for an extended period of time, it could lead the company to file for bankruptcy. This scenario could indicate that revenues or sales are declining while the accounts receivable component of a balance sheet is declining, which would be a red flag for investors.
There are several types of current assets that constitute net current assets. They may include cash or other assets that can be liquidated or converted to cash in a relatively short period of time. Features can include assets that can be sold or consumed within a year without interfering with daily business operations. In addition to cash, current assets can include cash accounts and deposits, accounts receivable, and short-term securities such as stocks that can be quickly liquidated. Also, inventory and prepaid expenses, including insurance, are all types of current assets.
In addition to paying down short-term debt obligations, a company can use net current assets to finance short-term expansion initiatives or for unplanned expenses. Investments that are less liquid and cannot be easily converted to cash are considered long-term investments. These assets could include company real estate, bonds, and equipment. Long-term assets are designed to be held by a company for more than one year.
Economist Benjamin Graham developed a trading strategy tied to buying stocks that were trading below current NAV. This is based on comparing the price of a share to the amount of net current assets. Stocks trading significantly below this value could have the potential to be trading investments.
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