Small Business Unplugged

Today I am continuing my series on Understanding Financial Statements. In Part 1 I wrote about how important it is to be able read your financial statements and linked to content from D&B Canada on How Financial Statements Are Put Together. In Part 2 we looked at the Balance Sheet And Profit And Loss Statement.

Today we take a look at the asset side of the equation. In a business assets represent property that is owned by your company. These are items and property owned or controlled by the business that have commercial value.

The term asset is also an accounting term used to describe cash and anything that the company could convert to cash, such as buildings, trucks, product inventories, equipment or other property. To learn more visit D&B Canada web page entitled Understanding Financial Statements.

Current Assets
Current Assets, also called trading assets, include cash, trade receivable and inventory. These are items that can be converted to cash within one year or in the normal operating cycle of a business. Also included in this category are any assets held that can be readily turned into cash with little effort, such as government and marketable securities.

Current Assets – Cash
Cash refers to cash on hand on in banks, checking account balances, and other instruments such as checks or money orders. A rule of thumb is that cash position is generally strongest after the peak selling season. When cash balances are continually small, it may be that a concern is experiencing slow receivable collection or some other financial weakness.

Current Assets – Marketable Securities
Marketable securities are found on many balance sheets. Marketable securities can include: government bonds and notes, commercial paper, and/or stock and bond investments in public corporations. Marketable securities are usually listed at cost or market price, whichever is lower. Accountants will frequently list securities at cost with a footnote indicating market price on the balance sheet date. (When marketable securities appear on a statement, it frequently indicates investment of excess cash.)

Current Assets – Accounts Receivable
Sales between most businesses are made on a credit basis. Accounts receivable indicate sales made and billed to customers on credit terms. A retailer, such as a department store, may show its customer charge accounts billed and unpaid in this category. In many businesses, accounts receivable are frequently the largest item on the balance sheet. You should pay special attention to this category and to credit terms offered by the company's health depends upon timely collection of receivables.

Every business that has accounts receivable, has some portion that it is unable to collect because customers fail to pay for one reason or another – mismanagement, disaster or intent. Usually a business will set aside an estimated allowance for these uncollectible or doubtful accounts. This allowance called "bad debt" is deducted from the total receivables shown on the balance sheet. Frequently a footnote identifying the amount deducted will be found in the statements.

Current Assets – Notes Receivable
Notes receivable represent a variety of obligations with terms coming due within a year. Notes receivable may be used by a company to secure payments from past-due accounts, or for merchandise sold on installment terms. In any case, notes receivable should be reviewed closely.

Current Assets – Inventory
You will find that inventory includes different items depending on whether a business is a manufacturer, wholesaler or retailer. Retailers and wholesalers will show goods that are sold "as is" with o further processing or supplies required in shipping. On the other hand, many manufacturers will show three different classes of inventory: raw materials, work-in-process or progress and finished goods. Raw materials are considered the most valuable part of inventory as they could be resold in the event of liquidation. Work-in-process has the least value because it requires additional labor and a sales effort to get rid of it if liquidation should occur. Finished goods are ready for resale. Finished goods value varies greatly according to circumstances. If they are popular products in good condition that can be easily sold, then the value shown might be justified. If the goods are questionable in salability, the value may be carried too high. The manufacturer's cost of labor employed in the production of finished goods and goods in process, as well as factory expenses is included in the value. Inventory is normally shown on the balance sheet at cost or market value, whichever is lower.

As a company's sales volume increases, larger inventories are required; however, problems can arise in financing their purchases unless turnover (number of time a year goods are bought and sold) is kept in balance with sales. A sales decline could be accompanied by a decrease in inventory in order to maintain a healthy condition. If a business has a sizable inventory, it may have partially completed or finished goods that are obsolete, or it could reflect a change in merchandising conditions.

Current Assets – Other Current
This category includes prepaid insurance, taxes rent and interest. Some conservative analysts consider prepaid items as noncurrent because they cannot be converted to cash to pay obligations quickly, and therefore have no value to creditors. Normally, this category is not large in relation to other balance sheet items, but if it is sizable there may be problems.

Noncurrent Assets
Noncurrent assets are items a business cannot easily turn into cash and are not consumed within business-cycle activity. We have defined current assets as those that can be converted into cash within one year. In the case of noncurrent assets, they are defined as assets that have a life exceeding a year.

Noncurrent Assets – Fixed Assets
Fixed assets are materials, goods, services and land used in the production of a company's goods. Examples include: real estate, buildings, plant equipment, tools and machinery, furniture, fixtures, office or store equipment and transportation equipment. All of these would be used in producing products for a company's customers. Land, equipment or buildings not used in the production of customer goods would be listed as other noncurrent assets or investments. Fixed assets are carried on the company's accounting books at the price they cost at the time of purchase.

All fixed assets, except land, are regularly depreciated since they eventually wear out. Depreciation is an accounting practice that reduces the fixed asset's carrying value on an annual basis. The reductions are considered a cost of doing business and are called a depreciation charge. Eventually the fixed asset will be reduced to its salvage or scrap value. Normally the accounting procedure is to list the fixed asset cost less accumulated depreciation, which would be shown on the statement or in a footnote. Bear in mind, not all companies can be comparable on this item as some rent their equipment and premises. If a business rents, its fixed asset total will be smaller compared with other balance sheet items.

Noncurrent Assets – Other Assets
under the other assets category, several items can be lumped together. The following items may be itemized separately on other balance sheets, and if significant, should be closely examined: investments, intangible, and miscellaneous assets.

Investments of a business represent assets of a permanent nature that will yield benefits a year or more after the date of the financial statement. These may include: investments in related companies such as affiliates (partly owned) and subsidiaries (owned and controlled); stocks and bonds maturing later than one year; securities placed in special funds; and fixed assets not used in production. The value of these items should be shown at cost.

Miscellaneous assets include advances to and receivables from subsidiaries, and receivables from officers and employees.

Intangible assets are those that may have great value to an operating company but have limited value to creditors. Analysts tend to discount these items or value them very conservatively. Intangible assets may be: a company's goodwill, copyrights and trademarks, development costs, patents, mailing lists and catalogs, treasury stock, formulas and processes, organization costs, and research and development costs.

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This entry was posted on Thursday, December 14th, 2006 at 12:19 pm and is filed under Misc. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.