Reviewed by Sep 30, 2020| Updated on
Short term refers to a period, and the actual duration is dependent on the law or regulations applicable. In the case of assets, a short term can refer to holding an asset for less than or equal to one year. In the case of current assets of a business, such as inventory or bills receivable, the short term period may be within six months.
Understanding Short Term
From an accounting perspective, a short term can refer to current assets and current liabilities of the foreseeable future. The term current refers to assets which are due for cash conversion and liabilities which are due for payment. The current assets and current liabilities are analysed for determining the ability of a company to generate cash to pay its current liabilities.
In the case of investments, such as mutual funds, stocks, or bonds, the same are short-term when held for a period of up to one year. The sale of short term securities generally gets taxed at a higher rate in comparison to long-term securities. Also, short-term and long-term investments have separate reporting requirements in the balance sheet.
In business, cash in hand, cash at bank, and other cash equivalents are short-term assets or current assets. Most current assets and current liabilities are short-term in nature. Even inventories of raw materials, semi-finished goods, and finished goods are short-term in nature and reported accordingly in the balance sheet.
Short term assets and liabilities are part of the computation of current ratio, liquidity ratio, inventory turnover ratio, and quick ratio. All these ratios examine the ability of a company to generate cash and pay its dues. A business should be able to quickly move its inventory and realise its receivables to finance its working capital needs.
Finance managers need to analyse the short term assets and liabilities, calculate, and analyse the short-term financial ratios to make day to day decisions about the business. The inventory turnover ratio calculates the frequency of conversion of inventory to sales.
The debtor's ratio shows how efficient a company is in collecting its receivables. In the case of securities, investors should be able to understand the short-term nature of the asset and the capital gains liability on its sale.
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