What is Short Term
Short term is a concept that refers to holding an asset for a year or less, and accountants use the term “current” to refer to an asset expected to be converted into cash in the next year or liability coming due in the next year. The accounting profession uses current assets and current liabilities to perform analysis, and in the investing industry, a security with a holding period of one year or less is a short-term security.
BREAKING DOWN Short Term
Short term is defined as current by accountants, so a current asset equals cash or an asset that will be converted into cash within a year. Inventory, for example, is converted into cash when items are sold to customers, and accounts receivable balances are converted into cash when a client pays an invoice. Both accounts receivable and inventory balances are current assets.
Short Term and Liquidity
Liquidity is a company’s ability to collect enough short-term assets to pay short-term liabilities as they come due. A business must be able to sell a product or service and collect cash fast enough to finance company operations. Managers must focus on liquidity as well as solvency, which is the process of generating sufficient cash flow to purchase assets over the long term.
Examples of Short-Term Financial Ratios
Managers make decisions with financial ratios, and there are several keys ratios used to make decisions about liquidity. The current ratio, for example, is stated as current assets divided by current liabilities, and the ratio measures the ability of a firm to pay its liabilities in the short term. Companies also use turnover ratios to calculate how quickly current assets can be converted into cash in the short term.
As an example, the inventory turnover ratio compares the cost of sales with inventory to measure how often the business sells its entire inventory in a year. Businesses also use the accounts receivable turnover ratio to analyze the number of days it takes to collect the average accounts receivable balance. If managers can effectively monitor short-term cash flow, the firm needs less cash to operate each month.
Short-Term Periods and Taxes
Investors need to be clear about whether a capital gain is short term or long term because taxation of the gain or loss is treated differently. For tax purposes, a long-term gain or loss means the security is held for a year or more, and long-term trading activity is separated from short-term transactions.