Assets I prioritize
In the previous post Balance sheet: taking the first steps, we began parsing the balance sheet of the imaginary workshop and focused on assets. Today, I suggest looking at what types of tangible and intangible property are classified as current assets and what types are classified as non-current assets.
Current assets contain the following items:
- Cash and cash equivalents - in our case we can include a safe with money, which, in general, corresponds to the company's cash in its current bank accounts.
- Net receivables - here we would include the IOU from a friend. That is everything that clients owe the company for goods or services.
- Inventory - this includes a bag with leather, rubber and thread. That is all raw materials, from which goods are made, as well as stocks of finished goods in warehouses.
- Other current assets - this can include other current assets that do not belong to the previous items.
Non-current assets include the following items:
- Net property, plant and equipment - we include a garage, table, chair, sewing machine and tools. Depreciation is deducted from the original cost of the property when reporting it. Depreciation is the cost to repair and renew the property.
- Equity and other investments - in our example, this would include oil company stocks (and in general, any company investment in stocks or bonds of other companies).
- Goodwill - let's say our company wants to buy another company and is willing to pay $11 million for it. The assets of the other company are $10 million, and the debts that our company will have to pay for the other company are $2 million. So the assets net of debt are $8 million. After the purchase, the assets and debts of that company will become the assets and debts of our company. So, the difference between the purchase amount of $11 million and the net assets of $8 million is a goodwill equal to $3 million. For our workshop, this item is not relevant, as it didn't buy any company. Nevertheless, remember that goodwill is the difference between the purchase price of another company and its net assets.
- Intangible assets - this can include the value of the customer base in the master's phone book, as well as any other assets that have no tangible basis (such as purchased trademarks).
- Other long term assets - this item includes other non-current assets that don't belong to the previous items.
Once we understand which asset belongs to which item, its value (or rather, the sum of the values of all assets belonging to this item) is written in the balance sheet. For example, let's say we've determined that the Inventory item includes leather, rubber, and thread. The accountant adds up the value of the leather, rubber, and thread and writes the total amount in monetary terms against the Inventory item. This is how the numbers appear in the balance sheet.
Now let's discuss which balance sheet items we should pay attention to during the fundamental analysis of assets. I have formulated the following rule for myself: pay attention to the assets that are directly related to the sale of the company's goods or services.
If a company does not sell its goods or services well, its bank account balance will shrink, huge inventories of unsold goods and raw materials will accumulate in its warehouses, and accounts receivable (customers debt) will grow. The fact is that when sales are bad, the company is ready to lend out goods as debt.
If sales are going well, then, on the contrary, the money in the account will grow, and accounts receivable and inventory will start to shrink. All other assets can influence sales only indirectly, so I don't consider them.
Thus, I have identified my priority assets:
- Cash and cash equivalents;
- Net receivables;
- Inventory.
As you can see, they are all quick current assets. Non-current assets only indirectly affect sales, so they are not a priority benchmark for me.
In the next post, we'll start looking at the right side of our disclosed book, called the Balance sheet. That's where the company's liabilities and equity belong. See you next time!
Current assets contain the following items:
- Cash and cash equivalents - in our case we can include a safe with money, which, in general, corresponds to the company's cash in its current bank accounts.
- Net receivables - here we would include the IOU from a friend. That is everything that clients owe the company for goods or services.
- Inventory - this includes a bag with leather, rubber and thread. That is all raw materials, from which goods are made, as well as stocks of finished goods in warehouses.
- Other current assets - this can include other current assets that do not belong to the previous items.
Non-current assets include the following items:
- Net property, plant and equipment - we include a garage, table, chair, sewing machine and tools. Depreciation is deducted from the original cost of the property when reporting it. Depreciation is the cost to repair and renew the property.
- Equity and other investments - in our example, this would include oil company stocks (and in general, any company investment in stocks or bonds of other companies).
- Goodwill - let's say our company wants to buy another company and is willing to pay $11 million for it. The assets of the other company are $10 million, and the debts that our company will have to pay for the other company are $2 million. So the assets net of debt are $8 million. After the purchase, the assets and debts of that company will become the assets and debts of our company. So, the difference between the purchase amount of $11 million and the net assets of $8 million is a goodwill equal to $3 million. For our workshop, this item is not relevant, as it didn't buy any company. Nevertheless, remember that goodwill is the difference between the purchase price of another company and its net assets.
- Intangible assets - this can include the value of the customer base in the master's phone book, as well as any other assets that have no tangible basis (such as purchased trademarks).
- Other long term assets - this item includes other non-current assets that don't belong to the previous items.
Once we understand which asset belongs to which item, its value (or rather, the sum of the values of all assets belonging to this item) is written in the balance sheet. For example, let's say we've determined that the Inventory item includes leather, rubber, and thread. The accountant adds up the value of the leather, rubber, and thread and writes the total amount in monetary terms against the Inventory item. This is how the numbers appear in the balance sheet.
Now let's discuss which balance sheet items we should pay attention to during the fundamental analysis of assets. I have formulated the following rule for myself: pay attention to the assets that are directly related to the sale of the company's goods or services.
If a company does not sell its goods or services well, its bank account balance will shrink, huge inventories of unsold goods and raw materials will accumulate in its warehouses, and accounts receivable (customers debt) will grow. The fact is that when sales are bad, the company is ready to lend out goods as debt.
If sales are going well, then, on the contrary, the money in the account will grow, and accounts receivable and inventory will start to shrink. All other assets can influence sales only indirectly, so I don't consider them.
Thus, I have identified my priority assets:
- Cash and cash equivalents;
- Net receivables;
- Inventory.
As you can see, they are all quick current assets. Non-current assets only indirectly affect sales, so they are not a priority benchmark for me.
In the next post, we'll start looking at the right side of our disclosed book, called the Balance sheet. That's where the company's liabilities and equity belong. See you next time!
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