Back to Basics, Part 3
The balance sheet is essentially a snapshot of a company's financial
position as of a particular date. It helps determine if a company has
enough money to continue funding its own growth or if it will need to
take on debt, issue debt, or return to the market with additional stock
offerings in order to plow ahead. By painting a picture of a company's
current financial health, it will aid you in determining whether a company
is capable of generating value for shareholders.
Like Luke vs. Darth, offense vs. defense, and "Tastes Great"
vs. "Less Filling," a balance sheet consists of two opposing
forces: assets vs. liabilities. We'll tackle them one at a time.
Assets are sources of value that can benefit a company down the road.
There are two major categories of assets: current and noncurrent. Current
assets are relatively liquid, meaning they can easily be converted into
cash. Current assets are expected to be converted into cash or used
up within one year. Noncurrent assets, conversely, are not easily converted
into cash. These can include property, equipment, goodwill, and deferred
Assets that will be used up within the next year or easily converted
into cash within one operating cycle are considered current. An operating
cycle is the time it takes to sell a product or service and collect
cash from that sale. It can last anywhere from 60 to 180 days or more.
Current assets can also be viewed as operating assets because they
fund the day-to-day operation of its business. Running low on current
assets will force a company to seek other sources of fuel for its operations,
usually leading to debt interest or dilution of shareholder value. Current
assets are listed on a balance sheet from top to bottom with the most
liquid at the top.
Let's review the terms you'll see under Current Assets.
Cash and Equivalents consist of cold, hard cash or
very liquid equivalents, such as money market funds or bearer bonds.
This is cash or insta-cash that is at the company's disposal for operations,
growth, dividends, and share repurchases.
Short-term Investments are just below cash and equivalents
in liquidity. When a company has cash over and above that needed for
operations, it can afford to sink some into short-term bonds that will
earn interest. While not as readily available as cash and equivalents,
short-term investments can be converted into cash without too much difficulty.
Accounts Receivable (A/R) is what is owed to a company
by its customers. Products or services have been rendered on credit
and the company is now siting next to its mailbox waiting for a check.
Usually, A/R will be converted into cash in a relatively short time.
However, if a customer cannot or will not pay and sending cousin Louie
after 'em doesn't prove beneficial, the company will be forced to take
a write-off for bad debt. The Allowance for Bad Debt you see next to
A/R in parentheses is money set aside to cover potential delinquent
Look at the rate of growth or decline in A/R and compare it to that
of revenue. Although an asset, A/R is not something you want to see
growing, much less outpacing revenues. A good portion of assets, such
as A/R, are paradoxical in nature -- we'll get more into that another
Inventories are the goods a company has for sale and
the materials used to produce those goods. It's idle money, like a caterpillar
in a cocoon, waiting to blossom merrily into flight and provide cash.
Sitting in that cocoon too long, however, is not only claustrophobic,
it can be costly. Companies need to turn inventory into cash as quickly
as possible to put that money back to work for them. Like A/R, inventories
outpacing revenue growth is a sign of trouble ahead.
Non-Trade Receivables is money due from sources other
than customer purchases. These can include tax refunds, interest income,
or the sale of property or equipment.
Restricted Cash is money set aside for a specific
purpose, generally spelled out in a contract. A company may not use
restricted cash for business operations, therefore it is listed separately
from Cash and Equivalents on a balance sheet.
Prepaid Assets, to finish off current assets, are
assets for which the company has paid the bill in advance for products
or services rendered. Although not a liquid asset, prepaid assets are
a bonus because these bills will not have to be paid in the future,
leaving greater future revenues at your disposal.
>> Noncurrent Assets >>