The classification of working capital can be divided into two categories:
- Current assets – assets that are used up or sold within 1 year
- Noncurrent assets – assets that are used up or sold within 3 years
Current assets include: Cash, short-term investments, accounts receivable, inventory and supplies.
Noncurrent Assets include: Long-term investments, property and equipment and intangible assets.
Some of the basic assumptions of the current asset include:
- That all the current assets will be realized within a year.
- That all the current liabilities will be paid with funds from existing operations or from external sources, such as new stocks or bonds.
- That no unusual prepayments or collections will occur.
- That no major additions to working capital will take place within a year’s period of time.
- That all current assets and liabilities will remain unchanged throughout the year.
Because of these assumptions, the balance sheet shows information that is only temporary in nature and thus may not be totally accurate, such as:
- Assets can be inflated because it shows inventories at cost rather than market value.
- Liabilities can be understated, because fixed assets are shown at acquired cost rather than fair market value.
- Liabilities can be overstated because the total of accounts payable and accrued expenses is greater than the balance of inventory and prepaid expenses.
Types of Expenses:
- Trade expenses: to buy or produce goods and services to sell them at a profit.
- Operating expenses: operating, administrative and marketing costs that are necessary for a business to operate such as labor, electricity, rent and depreciation.
- Selling expenses: expenses incurred by a company to sell its products.
- Administrative expenses: the unnecessary costs associated with a business that are not directly related to earning a profit.
When you have several accounts that have the same classification, it is called a pool of accounts and is accompanied by a “p” after the classification. For example, if you have accounts receivable, inventories and prepaid expenses, they would be classified as current assets. If there were another account that also had the same classification as those of current assets, such as rent, it would be considered a pool of accounts such as rent and would be accompanied by a “r” after the classification such as: Current assets – r.
When you have several accounts that have the same classification but one of them is different from the others, it is called a separate class and is followed by an “s” after the classification: Current assets –s.
When you have two or more accounts that have the same classification but one is a bank account, it is called a special class and is followed by a “b” after the classification.
When you have an account that has a different classification from normal accounts, it is called a sub-classify and is followed by a “c” after the classification.
Example: Current assets – r – b – c – p
Credit Allowances: An allowance for bad debts is an account for potential bad debts from credit sales.