Description of Components of Current assets

Loan and advances

Organizations across the world cannot function without funds. It is an essential part of a
business that ensures all the material required for production, administrative and operating
expenses of the entity are met in a timely manner. However, that’s not all that the funds are
used for. Companies need money to constantly invest to make their product or service better in
comparison to their competition. 
Individuals need funds to take care of a variety of requirements and carry on with their affairs
without any hurdles. Having said that, neither a company nor an individual has access to
unlimited funds. Loans and advances can fulfil this deficit in funds. 
Let’s deep dive into the definitions to understand the concepts with more clarity. 

What is a Loan?

When a financial institution offers a sum of money in the form of a debt to another enterprise or
individual that is meant to be paid back with interest within a specified period of time is referred
to as a loan.
For example, let’s say a personal loan has been sanctioned by a financial institution. Then, an
agreement is drawn up that outlines all the terms and conditions, the repayment amount and
time period, the interest, fees and any other applicable charges, etc. But before the loan is
approved, the financial institution will run a personal loan eligibility check to ensure that the
applicant meets the required criteria as per their policy.

What is an Advance?

The common concept of an advance hovers around a type of loan that is offered to a  business
entity or an individual may also seek an advance from a financial institution to meet short-term
requirements Thus, an advance is rather like a credit facility extended to a borrower, which he
may use to fulfill any short term requirements.
The advance is generally provided for a shorter duration of time, for instance, less than a year.

Difference Between Loans and Advances

Take a look at the common differences between loans and advances.

1. The Formality of Loans and Advances:

The first point of differentiation between loans and advances is in the fulfilment of formalities
that goes into getting the funds. Usually, the process of getting a loan sanctioned from a
financial institution is very formal in nature.
There are a lot of administrative procedures involved before the application of a loan is
accepted. The individual or enterprise has to undergo a strict screening process that checks if
the loan, along with interest can be repaid back to the institution on time.
The process is not quite the same for advances. Since the loan is being approved only if the
borrower meets pre-defined conditions such as enlisting primary security, guarantees or even a
collateral. Usually, the level of screening or procedures may not be as exhaustive or stringent as
it is offered by a lender to an existing customer.
2. Amounts Involved in Loans and Advances:

When a business or an individual makes a loan application, it is usually for a significant sum of
money (except for unsecured business loans, which are usually below 50 lakhs PKR). This can
be availed to kick start business operations, purchase inventory or spend it on research and
development. When individuals avail a loan, in most cases it is used for high-end expenditures
(except for personal loans which are usually below 25 lakhs PRK) such as buying a home,
purchasing a car, fund higher education or organise a wedding.  
On the other hand, advances made out to individuals or business entities are in much smaller
amounts that are extended to meet immediate and short-term financial objectives. 

3. Payment Duration in Loans and Advances:

The period of repayment between loans and advances is another point of differentiation. Loan
products such as personal loan, car loan, education loan or a home loan have a longer
repayment tenure. It can range anywhere from up to 5 years for a personal loan till up to 30
years for a home loan. The mode of repayment is via EMIs or Equal Monthly Installments as the
outlined tenure of the loan agreement.
Advances have a much smaller repayment period generally between 3 months to a year at the
most. Repayment terms may vary and depend on the agreement between the lender and the
borrower. 

4. Interests in Loans and Advances:

Loans from financial institutions attract an interest component which is added on to the principal
at the time of repayment. The interest component is proportionately spread across the
repayment tenure and is calculated based on the principal amount borrowed. The objective of
charging the is to cover the risk associated with sanctioning the funds and the time value or
money. 
The interest component on advances is usually very low since the repayment tenure is less than
12 months. Hence, the risk involved is much less as well as the monetary value. 

Trade Debts

Trade receivables are defined as the amount owed to a business by its customers following the
sale of goods or services on credit. Also known as accounts receivable, trade receivables are
classified as current assets on the balance sheet. Current assets are assets which are expected
to be converted to cash in the coming year.

Accrued interest

Accrued interest refers to the amount of interest that has been incurred, as of a specific date, on
a loan or other financial obligation but has not yet been paid out. Accrued interest can either be
in the form of accrued interest revenue, for the lender and reported in assets in balance sheet.  
 Stock in trade

Stock in trade or Inventories are assets that are held in ordinary course of business for sale or
use in the production of items for sale. Components included in stock in trade or inventories

 Raw material (items which are used in the production process e.g. limestone for cement
production, vehicle parts for vehicle manufacturing, etc.)
 Work in process (items which are in the production process at a particular point in time)
 Finished Goods (items which are ready for sale)

Stores, spare and loose tools

During the normal running of a manufacturing company, there are some materials which are
consumed as part of the daily operations, but cannot be considered as part of actual cost of
goods sold. These are materials in stores- like stationary, spares- used for maintenance of
equipment, and packing materials.

Since they are basically assets of the company and are most likely consumed in a year, they
have to be recorded as current assets, and therefore logically in the inventory.

Short-Term Investments / Marketable Securities

Similar to cash equivalents, these are investments in securities that will provide a cash return
within a single year. These types of securities can be bought and sold in public stock and
bonds markets. In the case of bonds, for them to be a current asset they must have a maturity
of less than a year; in the case of marketable equity, it is a current asset if it will be sold or
traded within a year. Marketable equity can be either common stock or preferred stock.

Prepaid Expenses 

Prepaid expenses are funds that have been spent preemptively on goods or services to be
received in the future. Payments to insurance companies or contractors are common prepaid
expenses that count towards current assets. A company can also choose to prepay rent it owes
on buildings or real estate; however, only one year’s worth of that prepaid rent counts towards
current assets.