Shareholders and Investors

What about Current Assets?
The first major component of the balance sheet is current assets, which are assets a company has at its disposal that can easily be converted into cash within one operating cycle. An operating cycle is the time it takes to sell a product and collect cash from the sale. It can last anywhere from 60 to 180 days.

Current assets are important because it is from current assets that a company funds its ongoing, day-to-day operations. If there is a shortfall in current assets, then the company is going to have to dig around to find some other form of short-term funding, which normally results in interest payments or dilution of shareholder value through the issuance of more shares of stock.

There are 5 main kinds of current assets –

  1. cash and equivalents;
  2. short- and long-term investments;
  3. accounts receivable;
  4. inventories and 
  5. prepaid expenses.

1. Cash & Equivalents:
These are assets which are money in the bank - literally cold, hard cash or something equivalent, like bearer bonds, money market funds, or vintage comic books. All right, it doesn't include vintage comic books. Cash and equivalents are completely liquid assets, and thus should get special respect from shareholders.

This is the money a company could immediately mail to you in the form of a fat dividend if it had nothing better to do with it. This is the money the company could use to buy back stock, and thus enhance the value of the shares that you own.

2. Short-Term & Long Term Investments:

These are a step above cash and equivalents. They normally come into play when a company has so much cash on hand that it can afford to tie some of it up in bonds with less than one year's duration. This money cannot be immediately liquefied without some effort, but it does earn a higher return than cash by itself. It is cash and investments that give shares immediate value and can be distributed to shareholders with minimal effort.

3. Accounts Receivable:

Normally abbreviated as A/R, this is the money currently owed to a company by its customers. The reason why the customers owe money is that the product has been delivered but not yet paid for. Companies routinely buy goods and services from other companies using credit.

Although typically A/R is almost always turned into cash within a short time, there are instances where a company is forced to take a write-off for bad accounts receivable if it has given credit to someone who cannot or will not pay. This is why you will see something called "allowance for bad debt" beside the accounts receivable number.

The allowance for bad debt is the money set aside to cover the potential for bad customers, based on the kind of receivables problems the company may or may not have had in the past. However, even given this allowance, sometimes a company will be forced to take a write-down for accounts receivable or convert a portion of it into a loan if a big customer gets into trouble.

Looking at the growth in accounts receivable, relative to the growth in revenues, is important.  If receivables are up more than revenues, you know that a lot of the sales for that particular quarter have not been paid for yet. We will look at accounts receivable turnover and days sales outstanding later in this series as another way to measure accounts receivable.

4. Inventories or Stocks:

These are the components and finished products a company has currently stockpiled to sell to customers. Not all companies have inventories, particularly if they are involved in advertising, consulting, services or information industries. For those that do, however, inventories are extremely important.

 Inventories should be viewed somewhat skeptically by investors as an asset. First, because of various accounting systems like FIFO (first in, first out) and LIFO (last in, first out) as well as real liquidation compared to accounting value, the value of inventories is often overstated on the balance sheet. Second, inventories tie up capital.

Money that it is sitting in inventories cannot be used to sell it. Companies that have inventories growing faster than revenues, or that are unable to move their inventories fast enough, are sometimes disasters waiting to happen. We will look at inventory turnover later as another way to measure inventory.

5. Prepaid Expenses:

These are expenditures the company has already paid to its suppliers. This can be a lump sum given to an advertising agency or a credit for some bad merchandise issued by a supplier. Although this is not liquid in the sense that the company does not have it in the bank, having bills already paid is a definite plus. It means that these bills will not have to be paid in the future, and more of the revenues for that particular quarter will flow to the bottom line and become liquid assets.