Net Current Asset: Definition, How to Calculate It and Uses
By Indeed Editorial Team
Published 5 May 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Investors and financial professionals evaluate several variables when assessing a company's financial stability. One such variable is net current assets, otherwise called working capital. Evaluating a company's working capital allows investors and analysts to estimate the value of an organisation's current assets relative to its current liabilities, allowing them to better gauge its financial health. In this article, we define net current assets, describe how to calculate it, share some tips and outline its uses.
What is a net current asset?
A net current asset (NCA) is a numerical value that represents the difference you get from deducting a company's current assets from its current liabilities. It's also called working capital or shareholders' equity and it's an important metric for determining an organisation's financial health. If the net current assets are greater than the current liabilities, the working capital is positive and indicates the company has a positive standing and enough assets to pay creditors.
Positive shareholder equity shows investors a company has adequate liquidity to operate effectively and discharge its corporate obligations efficiently. It can also indicate sound management practices and prudent fiscal responsibility, making the business an attractive candidate for investors and financiers. Before you can calculate working capital, it's important to know how to determine current assets and current liabilities. Here's a simple formula for calculating this metric:
NCA = Current assets - current liabilities
What are current assets?
Current assets are all the assets an organisation expects to use, exhaust or sell to cover its operating activities over a one-year period. These assets include cash and cash equivalents, stock inventory, accounts receivable, pre-paid liabilities, short-term investments and other assets the business can liquidate to finance its standard operations each year. Current assets are also called current accounts and appear on an organisation's balance sheet.
What are current liabilities?
Current liabilities are short-term financial obligations due within a year or a company's normal operating period. Examples of current liabilities include unpaid bills a company owes to vendors, income taxes the company owes the government and employee wages. Loans a company took from a bank, dividends and notes payable are also current liabilities.
What is NCAVPS?
NCAVPS is an acronym for net current asset value per share. It's a means of estimating the attractiveness of a stock, which is important for value investors. If you're in the investment industry, it's important to know how to calculate NCAVPS because it allows you to gauge a company's financial assets and liabilities relative to the value of individual stocks.
Before potential investors decide to invest in an organisation, they may compare the company's NCAVPS to the current trading price of its stock. If the stock is selling at less than the NCAVPS, it means it's trading at a value less than the company's liquidation value, which is the total worth of all its physical assets that can be sold if the company liquidates. What this means is that investors are actually buying a stake in the organisation at a cheaper rate. Investors are likely going to make gains if they buy the stock below the liquidation value.
Formula for calculating NCAVPS
Here's the formula for calculating NCAVPS:
NCAVPS = (Current assets - total liabilities) / number of shares outstanding
Here's an overview of the definitions of each parameter in this equation:
Current assets: All the cash, cash equivalents and assets the company can convert into cash within a year.
Total liabilities: These are the combined debts a company owes.
Shares outstanding: This is the number of stocks currently owned by individuals, groups and institutional investors distinct from the company itself.
How to calculate NCAVPS
Follow these steps to calculate NCAVPS using the formula above:
1. Calculate current assets
The first step is to calculate current assets. This information is usually available on the company's balance sheet, and it's part of the documentation businesses raising money from the public are required to release every year. Current assets cover all the cash and cash equivalents and assets the organisation can use to finance its operations within a year.
2. Calculate total liabilities
Total liabilities include all the debt a company owes. It covers current liabilities, which include short-term financial obligations the business is required to pay back within a year and long-term debt. To calculate total debt, add current liabilities to long-term liabilities.
3. Determine shares outstanding
Shares outstanding is the total number of a company's stock currently owned by shareholders. These include shares held by individuals, institutional investors, insiders and company employees and officers. Shares outstanding are called capital stock on the company balance sheet to indicate that they don't belong to the organisation.
Example of NCAVPS calculation
Here's an example of calculating NCAVPS:
A company's balance sheet shows it has current assets and long-term assets worth $70,000 and $30,000, respectively. The company has current liabilities of $20,000 and long-term debt worth $10,000. Calculate the NCAVPS if the value of shares outstanding is 2,000.
Now that you know the current assets, total liabilities and shares outstanding, you can use the values to determine NCAVPS using this formula:
NCAVPS = (Current assets - total liabilities) / shares outstanding
NCAVPS = [($70,000 - ($20,000 + 10,000)] / 2,000
NCAVPS = [($70,000 - $30,000)] / 2,000
NCAVPS = $40,000 / 2,000 = $20
NCAVPS = $20
To know whether the company's shares are undervalued, compare them to the NCAVPS. According to the 66% rule of value investing, if the stock's current price is lower than 66% of its NCAVPS, then you're buying it at a discounted rate.
Tips for using NCAVPS and net current assets
Here are some tips for using NCAVPS and its derivatives when making investment and business decisions:
Compare figures within the same industry
The insights you get from evaluating current assets and liabilities of businesses in different industries can skew your understanding of their financial health. In some industries, such as the financial services sector, companies tend to have more liabilities because they operate on an accrual basis. A better way to assess the liquidity of such organisations is to check their accounts receivables and the success of their credit collection system.
When assessing these types of companies for investment opportunities, it's better to compare their NCAVPS to similar organisations in their industry rather than businesses that operate on a cash basis and have higher levels of liquidity.
Understand how NCAVPS differs from stock prices
Value investors often resort to NCAVPS to determine whether to invest in a company they think is undervalued. While the NCAVPS is a good indicator that investors are likely going to recoup their investment in a company if it liquidates, the variables for calculating it are within the organisation's control. This makes it important to do due diligence and analyse the historical performance of the business before concluding it's a valuable asset.
Understand the limitations of NCAVPS
NCAVPS is only an estimate of the value of a company's asset when it liquidates, which means there's a risk of overestimating the organisation's liquidation value. Depending on the time, economic condition and other variables, the liquidation value of a company selling its assets might be far from the estimation derived from NCAVPS calculations. Factors such as depreciation, amortisation and the inability to sell obsolete equipment and several other variables can cause the value of assets and liabilities to increase or decrease significantly.
What is the difference between current assets and liquidity?
Current assets are almost synonymous with liquidity, but they're different. Liquidity refers to the ability to convert an asset into cash or a cash equivalent to finance operational activities. It can also mean a company's ability to settle bills when they're due. Liquidity typically includes current assets you can convert to cash within one operating cycle. For operational purposes, cash is the most liquid asset because an organisation can use it to pay bills at short notice. Short-term investments, stock inventory, pre-paid liabilities and accounts receivables are also forms of liquidity.
While calculating current assets involves adding cash and cash equivalents and other assets a company can convert to cash, you determine liquidity by dividing the number of quick assets by current liabilities.
Uses of working capital
Here are some uses of working capital:
Determine short-term financial health
Working capital can help investors and analysts evaluate the short-term financial health of a company. This is because it provides information about the cash and cash equivalents available to the business for daily operations. It can also show the level of liquidity and assets the company has to meet its financial obligations.
Before investing in a company, it's important to assess the risk level of the organisation. Looking at the financial statement to compare the current assets and liabilities can show you whether buying a company's stock is a risky move or may likely provide benefits to clients. One way to do this is to compare the company's NCAVPS to the current price of its stock on the market.
Determine liquidity position
Calculating a company's NCA relative to its total or current liabilities can help evaluate its liquidity position. This can show investors how the business funds its daily operations. It can also help measure the organisation's capacity to pay creditors without raising funds from third parties.
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