Current Assets The first thing listed under the asset column on the balance sheet is something called

"current assets". This is where companies list all of the stuff that can be converted into cash in a short period of time [usually a year or less]. Because these assets are easily turned into cash, they are sometimes referred to as "liquid". They normally consist of: Cash and Cash Equivalents ash and ash !quivalents is the amount of money the company has in ban" accounts, savings bonds, certificates of deposit, and money mar"et funds. #t tells you how much money is available to the business immediately. $ow much should a company "eep on the balance sheet% &enerally spea"ing, the more cash on hand the better. 'ot only does a decent cash hoard give management the ability to pay dividends and repurchase shares, but it can provide e(tra wiggle)room when times get bad. There are some cases where cash on the balance sheet isn*t necessarily a good thing. #f a company is not able to generate enough profits internally, they may turn to a ban" and borrow money. The money sitting on the balance sheet as cash may actually be borrowed money. To find out, you are going to have to loo" at the amount of debt a company has +we will be discussing this later on in the lesson,. The moral: -ou probably won*t be able to tell if a company is wea" based on cash alone. the amount of debt is far more important. Short Term Investments These are investments that the company plans to sell shortly or can be sold to provide cash. /hort term investments aren*t as readily available as money in a chec"ing account, but they provide added cushion if some immediate need were to arise. /hort Term #nvestments become important when a company has so much cash sitting around that it has no qualms about tying some of it up in slightly longer)term investment vehicles +such as bonds which have maturities of less than one year,. This allows the business to earn a slightly higher interest rate than if they stuc" the cash in a corporate savings account. 0erhaps the most legendary cash hoard in the business world right now is 1icrosoft*s ) the company has 23.43 billion in cash and 254.675 billion in short term investments. Receivables 8lso sometimes "nown as "8ccount 9eceivables", this is money that is owed to a company by its customers. $ere*s how it wor"s: :et*s say ;al)1art wants to order a new <=< which is being released by ;arner Brothers. ;al)1art orders 3>>,>>> copies for its stores. ;arner Brothers receives the order, and within a wee", ships the <=<s to one of ;al)1art*s warehouses. #ncluded in the shipment is a bill +let*s say ;B charged ;al)1art 23 per <=< for half a million copies ) that*s 24.3 million,. ;arner Brothers has already sent the movies to ;al)

1art, even though ;al)1art hasn*t paid a penny. #n essence, ;al)1art is buying on credit and promising to pay ;B*s the 24.3 million. The 24.3 million would go on ;arner Brother*s balance sheet as receivables. &enerally a company that sells a product on credit sets a term. The term is the number of days customers must pay their bill before they are charged a late fee or turned over to a collection agency +most terms are, 5>, ?> or 6> days,. #f ;arner Brothers sold the <=<s to ;al)1art on a 5> day term, ;al)1art must pay its bill during that time. ;hile accounts receivable are good, they can bring serious problems to a business if they aren*t handled properly. ;hat if ;al)1art went ban"rupt or simply didn*t pay ;arner Brothers% ;B would then be forced to write down its receivables on the balance sheet by 24.3 million. This is what is called a delinquent account. 'ormally, companies build up something called a reserve to prepare for situations such as this. 9eserves are set amounts of money that are ta"en out of the profits each year and put into an account specifically designed to act as a buffer against possible loses the company may incur. +9eserves are touched on in 0art 46,. ;hen customers don*t pay their bills, companies can ta"e money out of the reserve they had built up to pay bac" suppliers. Receivable Turns ommon sense tells you the faster a company collects its receivables, the better. The sooner customers pay their bills, the sooner a company can put the cash in the ban", pay down debt, or start ma"ing new products. There is also a smaller chance of losing money to delinquent accounts. @ortunately, there is a way to calculate the number of days it ta"es for a business to collect its receivables. The formula loo"s li"e this: redit /ales +found on the income statement ) not the balance sheet, )))))))))))))))))))))))))+divided by,))))))))))))))))))))))))))) 8verage 9eceivables :et*s loo" at an e(ample. $.@. Beverages Balance /heet +!(cerpt, 2000 9eceivables 2A,AB5,5?5 #ncome /tatement +!(cerpt, redit /ales 2A3,?>B,5>> 1999 2A,A7B,C45

$.@. BeveragesD is a maEor manufacturer of soft drin"s and Euice beverages. #t sells to supermar"ets and convenience stores across the country on a 5> day term. To see if

customers are paying on time, we need to loo" for the income statement. #t is normally found within a page or two of the balance sheet in the annual report or A>F. ;ith the income statement in front of you, loo" for an item called " redit /ales" +if you can*t find it, there is an item called "Total /ales" which is acceptable but not as accurate,. #n 4>>>, $.@. Beverages reported credit sales of 2A3,?>B,5>>. #f we loo" at the e(cerpt from its balance sheet +above,, we will see that in 4>>>, it had 2A,AB5,5?5 in receivables and in A666, 2A,A7B,C45. ;e need to find out the average amount of receivables $.@. had in 4>>>, so we would ta"e 2A,AB75,5?5 G 2A,A7B,C45 and divide it by 4. The answer is 2A,AB>,B65. 0lug the two numbers into the formula. redit /ales H 2A3,?>B,5>> ))))))))))))+divided by,)))))))))))))) 8verage 9eceivables H 2A,AB>,B65 The answer, called "9eceivable Turns" by financial analysts, is A5.4A75. This means that $.@. Beverages collects its accounts receivable A5.4A75 times per year. Ince you calculate this number, finding out the number of days it ta"es for customers to pay their bills is simple. /ince there are 5?3 days in a year and the company gets A5.4A75 turns per year, ta"e 5?3 J A5.4A75. The answer is the number of days it ta"es the average customer to pay +in $.@.*s case, we come up with 47.?A,. This means the company is doing a good Eob managing its accounts receivable because customers aren*t e(ceeding the 5> day policy. $ad the answer been greater than 5>, you would have been wise to try to find out why there were so many late payments, which could be a sign of trouble. +Feep in mind you will need to read through the company*s reports to find out what its collection deadline is. 'ot all companies require their customers to pay within 5> days,. Inventories ;hen loo"ing at a company*s current assets, you need to pay special attention to inventory. #nventory consists of merchandise a business owns but has not sold. #t is classified as a current assets because investors assume that inventory can be sold in the near future, turning it into cash. To come up with a balance sheet amount, companies must estimate the value of their inventory. @or instance, if 'intendo had 3,>>> units of its new video game system, the &ame ube, sitting in a warehouse in Kapan, and e(pected to sell them to retailers for 25>> each, they would be able to put 2A,3>>,>>> on their balance sheet as the value of their current inventory +3>>> units ( 25>> each H 2A.3 million,. This presents an interesting problem. ;hen inventory piles up, it faces two maEor ris"s. The first is the ris" of obsolesce. #n another year, few stores will probably be willing to buy the &ame ube video game system for 25>> simply because a newer, faster, and better system may have come along. 8lthough the inventory is carried on the balance sheet at 2A.3 million, it may actually lose value as time passes. ;hen you hear that a company has

ta"en an inventory write)off charge, it means that management essentially decided the products that were sitting in storage or on the store shelves weren*t worth the values they were stated at on the balance sheet. To correct this, the company will reduce the carrying value of its inventory. #f a year passes and 'intendo still has 5>>> of the 3>>> units in storage, the e(ecutives may decide to lower their prices hoping to sell the remaining inventory. #f they lower the &ame ube*s price to 24>> each, they would have 5>>> units at 24>>. Before, those 5>>> units were stated at a value of 26>>,>>> on the balance sheet. 'ow, because they are selling for less, the same units are only worth 2?>>,>>>. The ris" of obsolesce is especially present in technology companies or manufacturers of heavy machinery. 8nother inventory ris" is spoilage. /poilage occurs when a product actually goes bad. This is a serious concern for companies that ma"e or sell perishable goods. #f a grocery store owner overstoc"s on ice cream, and two months later, half of the ice cream has gone bad because it has not been purchased, the grocer has no choice but to throw it out. The estimated value of the spoiled ice cream must be ta"en off the grocery store*s balance sheet. The moral of the story: the faster a company sells its inventory, the smaller the ris" of value loss.

Current Liabilities urrent liabilities are the debts a company owes which must be paid within one year. They are the opposite of current assets. urrent liabilities includes things such as short term loans, accounts payable, dividends and interest payable, bonds payable, consumer deposits, and reserves for @ederal ta(es. :et*s ta"e a loo" at some of the most common and important ones. Accounts Pa able 8ccounts payable is the opposite of accounts receivable. #t arises when a company receives a product or service before it pays for it. Accrued !ene"its # Pa roll This is money owed to employees as salary and bonus that the company has not yet paid. Short Term and Current Lon$ Term %ebt These items are sometimes referred to as notes payable. They are the most important item under current liabilities. 1ost of the time, they represent a company*s ban" loans. Borrowing money in itself is not necessarily a sign of financial wea"ness. an intelligent

department store e(ecutive may wor" out short term loans at hristmas so she can stoc" up on merchandise before the $oliday rush. #f demand is high, the store would sell all of its inventory, pay bac" the short term loans, and poc"et the difference. This is "nown as utiliLing leverage. The department store used borrowed money to ma"e a profit. /o how can you ever hope to tell if a company is wisely borrowing money +such as our department store,, or rec"lessly going into debt% :oo" at the amount of notes payable on the balance sheet +if they aren*t classified under *notes payable*, combine the company*s short term obligations and long term current debt., #f the amount of cash and cash equivalents is much larger than the notes payable, you shouldn*t have any reason to be concerned. #f, on the other hand, the notes payable has a higher value than the cash, short term investments, and accounts receivable combined, you should be seriously concerned. Mnless the company operates in a business where inventory can quic"ly be turned into cash, this is a serious sign of financial wea"ness. &ther Current Liabilities <epending on the company, you will see various other current liabilities listed. /ometimes they will be lumped together under the title "other current liabilities." 'ormally, you can find a detailed listing of what these "other" liabilities are buried somewhere in the annual report or A>". Iften, you can figure out the meaning of the entry by its name. #f a business lists " ommercial 0aper" or "Bonds 0ayable" as a current liability, you can be fairly confident the amount listed is what will be paid out to the company*s bond holders in the short term. Consumer %e'osits #f you are loo"ing at the balance sheet of a ban", you will want to pay close attention to an entry under the current liabilities called " onsumer <eposits". Iften, they will be will lumped under other current liabilities. This is the amount that customers have deposited in the ban". /ince, theoretically, all of the account holders could withdrawal all of their funds at the same time, the ban" must list the deposits as a current liability.

(o) much * ca'ital com'an need To find the appro(imate amount of wor"ing capital a company should have, you should loo" at "wor"ing capital per dollar of sales." #n other words, you are going to have to compare the amount of wor"ing capital on the balance sheet to the total sales +which is found on the income statement ) not the balance sheet,. 8 business that sells a lot of low)cost items, and cycles through its inventory rapidly +a grocery store, may only need A>)A3N of wor"ing capital per dollar of sales. 8 manufacturer of heavy machinery and high)priced items with a slower inventory turn may require 4>)43N wor"ing capital per dollar of sales. 8 company such as oca ola would probably fall somewhere between the two.

$ere*s the formula for ;or"ing

apital per <ollar of /ales

;or"ing apital )))))))))))))))))))))))))+divided by,))))))))))))))))))))))))))) Total /ales +@ound on the #ncome /tatement, :et*s loo" at an e(ample: +oodrich, Inc- .S mbol +R/ &oodrich provides systems for aircraft as well as manufacturers heavy)duty engines. ;or"ing apital: 2655,>>>,>>> +current assets ) current liabilities, Total /ales +found on the income statement) H 2C,5?5,B>>,>>> :et*s plug the numbers into the formula: ;or"ing apital H 2655,>>>,>>> )))))))))))))))))))))))))+divided by,))))))))))))))))))))))))))) Total /ales +@ound on the #ncome /tatement, H 2C,5?5,B>>,>>> The answer for &oodrich is .4A5B, or 4A.5BN. 8s a manufacturer of heavy duty machinery, &9 falls within the 4>)43N wor"ing capital per dollar of sales range. This is good.

0e$ative *or1in$ Ca'ital /ome companies can generate cash so quic"ly they actually have a negative wor"ing capital. This is generally true of companies in the restaurant business +1c<onalds had a negative wor"ing capital of 2?6B.3 million between A666 and 4>>>,. 8maLon.com is another e(ample. This happens because customers pay upfront and so rapidly, the business has no problems raising cash. #n these companies, products are delivered and sold to the customer before the company ever pays for them. <on*t understand how a company can have a negative wor"ing capital% Thin" bac" to our ;arner Brothers O ;al)1art e(ample. ;hen ;al)1art ordered the 3>>,>>> copies of a <=<, they were supposed to pay ;arner Brothers within 5> days. ;hat if by the si(th or seventh day, ;al)1art had already put the <=<s on the shelves of its stores across the country% By the twentieth day, they may have sold all of the <=<s. #n the end, ;al)1art received the <=<s, shipped them to its stores, and sold them to the customer +ma"ing a profit in the process,, all before they had paid ;arner BrothersP #f ;al)1art can continue to do this with all of its suppliers, it doesn*t really need to have enough cash on hand to pay all of its accounts payable. 8s long as the transactions are timed right, they can pay each bill as it comes due, ma(imiLing their efficiency. The bottom line: 8 negative wor"ing capital is a sign of managerial efficiency in a business with low inventory and accounts receivable +which means they operate on an almost strictly cash basis,. #n any other situation, it is a sign a company may be facing ban"ruptcy or serious financial trouble.