Let examine each component in detail.
Cash is the amount of money a company has in its bank account. Cash is necessary for paying bills and for maintaining the day to day operations. As you can see, The Toy Company has $10,122 cash in its bank account on December 31, 200X. This balance will change on the following day if any of the following activities take place: if the company makes cash sales, pays on its debt, receives additional investments or loans, pays on expenses, and other transactions requiring cash.
Many businesses, having extra cash in the bank, may decide to pay down liabilities, invest into new markets, or buy marketable securities. A marketable security, in most cases, is a very short term investment a business purchases from the government, for instance.
An account receivable is a promise by a customer to pay for a product or service at a later point in time. Many of us have purchased items on credit, promising to pay for them in the future. Companies offer credit terms as an added service to customers in an attempt to increase sales. When you, as a consumer, purchase something on credit, the company you purchase the product or service from will consider you an account receivable. If you, as a business owner, allow customers to buy your products on credit, then those customers are considered accounts receivable. As of December 31, 200X, The Toy Company has $5,000 outstanding in accounts receivable. This means, some of the company's customers purchased $5,000 worth of toys, and as of December 31, 200X, haven't paid for them.
Usually businesses will give their customers 30 days to pay for items placed on credit. The pay back period, however, depends on the industry norm and the company's credit granting policy. Most businesses charge interest to customers who fail to pay within an allotted time frame. The interest rate varies from company to company, however, it usually ranges between 2 and 5 percent of the amount owed.
Prepaid items are expenses businesses pay for in advance. Common prepaid expenses include, prepaid rent and prepaid insurances. You may ask why would a business pay for something that is not due. Proper cash management dictates "not to pay for something unless it's due". Some contracts. however, call for payment of goods and services up front. Think about your personal car insurance. If you are not on a monthly payment plan, chances are you're required to pay for your automobile insurance in advance; usually six months in advance.
Prepaid items are considered assets because full payment is made for services that have not been fully rendered. As a company receives the service, the prepaid item is no longer an asset, but rather an expense. To explain this concept, lets refer back to one of our assumptions which stated.
"On July 1, 200X, The Toy Company purchased fire insurance on its building and its inventory of toys. The insurance company quoted a yearly rate of $2,400. The insurance contract called for 1 year payment to be made in advance".
In short, on July 1, 200X Donald wrote a $2,400 check to his
insurance company. The fire insurance "covers" the building and inventory for a 1 year period. Therefore, on July. 200X, The Toy Company's balance sheet would show an account called prepaid fire insurance for $2,400. The company's balance sheet as of December 31, 200X, however, shows the prepaid fire insurance account balance as $1,200. From July 1 through December 31, 200X, the prepaid fire insurance account reduced by $1,200 ($2,400 - $1,200 = $1,200). The reason behind the reduction is simple. The $2,400 paid on July 1 protects the company against fire for a 1 year period (from July 1, 200X to July 1, 200Y). Since six months of the insurance has expired ( July to December of 200X), only six more months is left on the insurance policy (from January to July 1 of 200Y). Therefore, only six months (or half) of the policy still has value to the Toy Company. The other six months of the insurance has no value and is considered to be an expense. The Income Statement on December 31, 200X would show an account called Fire Insurance Expense. The fire insurance expense would have a value of $1,200 - the used or consumed portion of the insurance policy.
Inventory is the product a company buys or produces and sell to end consumers (you and I). For example, The Toy Company is a retailer that buys products from a wholesaler and sells them to end consumers. Most retailers and service providers buy finished inventory and sell it to end consumers. A manufacturer, on the other hand, buys raw materials and manipulates (manufactures) those materials into finished products. A retailer's inventory generally is "finished" and ready for resale upon unpacking the products. Where as a manufacturer may have three types of inventory - raw materials, work in process, and finished goods inventory.
If you are a retailer/service provider your inventory is always recorded at its cost (IE historical value). That is; the money you pay your suppliers for the goods you buy for resale plus any shipping charges. Thus, as of December 31, 200X The Toy Company has finished inventory on hand valued at $12,558. Therefore, The Toy Company paid wholesalers and shipping companies $12,558 for the toys that are on display and that are in storage. The inventory will decrease in value if the company makes sales to customers. The inventory account will increase when more inventory is purchased. Remember when a sale is made the inventory is removed and is recorded as a cost of good sold (COGS). Cost of Goods Sold appears on the Income Statement.
If you are a manufacturer, your inventory will be recorded at the cost of all raw materials, plus direct labour costs (labour costs directly related to producing the finished product), plus factory overhead charges required in manufacturing the raw materials into finished products. Usually, manufacturers will separate finished goods (products ready for resale) from non-finished goods (raw materials and work in process) on the balance sheet.
Total Current Assets
Total current assets is the sum of all the current assets listed on a company's balance sheet. As indicated below, The Toy Company has total current assets valued at $28,880.