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Financial Statement Analysis

Assets

First, let us begin with explaining the concept of ‘Asset.’

 

Assets are resources owned/controlled by any economic entity that is expected to provide some future economic benefit. Assets can be created by operating activities (e.g., generating net profit), investing activities (e.g., purchasing manufacturing equipment) and financing activities (e.g., issuing debt).

 

There are two main types of assets:

  • Current assets
  • Non-current assets

Current Assets:

Current assets are those assets that can be easily converted into cash or used within one year or one operating cycle, whichever is greater. Four very important current asset items found on the balance sheet are:

 

  • Cash:

Generally, investors are attracted to companies with plenty of cash on their balance sheets. After all, cash offers protection against tough times and it gives companies more options for future growth. Cash is the most liquid current asset.

 

  • Accounts Receivables:

Receivables are outstanding (uncollected bills) amounts owed by customers (individuals or corporations) to a business entity in exchange for goods or services that have been delivered or used but not yet paid for. Receivables usually come in the form of operating lines of credit and are usually due within a relatively short time, ranging from a few days to a year. The accounts receivable is recorded on the asset side of a public company's balance sheet because this represents a legal obligation for the customer to remit cash for its short-term debts. 

 

Analyzing the speed at which a company collects its receivables can tell us a lot about its financial efficiency. The company may be letting customers stretch their credit in order to recognize greater top-line sales and that can spell trouble later on, especially if customers face a cash crunch.

 

  • Inventories:

Inventories are items held for sale or used in the manufacturing of goods to be sold later. Manufacturing firms separately report inventories of raw materials, work-in-progress and finished goods.

 

Companies have limited funds available to invest in inventory. To generate the cash to pay bills and return a profit, they must sell the merchandise they have purchased from suppliers. Thus, when inventory grows faster than sales it is almost always a sign of deteriorating fundamentals.

 

Possessing a high amount of inventory for a long period is not usually good for a business because of inventory storage, obsolescence and spoilage costs. However, possessing too little inventory isn't good either because the business runs the risk of losing out on potential sales and potential market share as well.

 

Investors must keep an eye on the Inventory Turnover Ratio to judge how fast the company is able to convert its inventory to sales. A low turnover ratio might signify slow sales coupled with excessive inventory levels. Similarly, a high ratio might point to fast sales & low inventory levels.

 

The lower the levels of inventory, the lower the working capital tied to a business. 

 

  • Marketable Securities:

Marketable securities are non-strategic debt or equity securities in which the company has invested, that are traded in a public market. They are liquid securities that can be readily converted into cash quickly at a reasonable price. Marketable securities are liquid in nature as they tend to have maturities of less than one year.

 

Furthermore, the rate at which these securities can be bought or sold has little effect on their prices.

 

Examples of marketable securities include commercial papers, banker's acceptances, treasury bills, equity investments, amongst others.

 

Current assets:

(a) Inventories

(b) Biological assets other than bearer plants 

(c) Financial assets

  • Investments
  • Trade receivables
  • Cash & cash equivalents
  • Other bank balances 
  • Loans

(d) Other current assets 

 

Non- Current Assets:

Non-current assets can be defined as all those assets that are not expected to be converted into cash in the next financial year. This includes fixed assets such as property, plant and equipment (PP&E). Unless the company is in financial distress and is liquidating assets, investors need not pay too much attention to fixed assets.

 

Other non-current assets include Intangible assets. Intangible assets are unidentifiable, cannot be purchased separately and may have an infinite life e.g. goodwill. Intangible assets with finite life are amortized every year e.g.software, patents, etc.

 

Goodwill is seen as an intangible asset on a firm's balance sheet because it is not a physical asset such as building and equipment. Goodwill is the excess of purchase price over the fair value of the identifiable assets and liabilities acquired in a business acquisition.

 

For example, if company A acquired company B by paying ₹600 million and at the acquisition date the fair value of company B's assets is only ₹560 million then on company A's books, the excess of ₹40 million which is paid will be recorded as goodwill.

 

Non-current assets:

 

(a) Property, plant & equipment


(b) Capital work in progress


(c) Goodwill on consolidation


(d) Other intangible assets


(e) Intangible assets under development 


(f) Financial assets

  • Long term investments
  • Investments in associates 
  • Investments in a joint venture
  • Loans

(g) Other non-current assets

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Units 10/14