The asset side of balance sheet highlights how funds are invested in assets to
carry out business operations. Assets are further sub-classified into long term
or fixed and current depending on its usage and nature.
Current Assets
Current assets are working capital used to finance day to day operations of a business.
These assets have a short life and are expected to be converted into cash within
one year. Current assets are important for the smooth operation of business
activities. An operating cycle of a business i.e. time span between acquisition
of raw materials and supplies to realization of cash from sales, is funded by
current assets. Ideally current assets are funded by both current liabilities
and other long term capital available in the business.
Cash includes cash in hand i.e. what is in the petty cash and
with the cashier, and bank balances. Certain amount of liquid cash is always
maintained in business to ensure smooth operation. It should be cautioned that,
liquidity and profitability are negatively correlated, too much cash holding
would cause greater opportunity cost in terms of lost interest income and insufficient
cash balances may lead to overdrawn bank balances resulting in exorbitant interest
expenses.
Marketable
Investments also known as marketable securities are
short-term investments in mostly risk free financial instruments. These investments
are in highly liquid form or in cash equivalents and have a short maturity so
that funds can be withdrawn as needed without incurring a significant loss (However,
there is a transaction cost to it which is insignificant and can be ignored).
Marketable investments include treasury bills, promissory notes, negotiable
instruments and commercial papers. The valuation of marketable investments is
based on lower of cost or market value.
Receivables are amounts outstanding from the customers and non-trade
nature receivables. The amount is net realizable value after provisioning for
any doubtful elements.
Inventories are goods held for sale and items used for manufacturing.
This is a significant element in the current assets and requires attention when
analyzing the balance sheet. Inventories tie up capital and thus can influence
the profitability of an enterprise. The valuation of inventories could have
sizeable effect on the financial position of business on the other hand. There
are three methods of inventory accounting; first in first out (FIFO), last in
first out (LIFO) and average method. The final valuation should be on the basis
of lower of cost or market value. Investments in inventory depend upon the nature
of the industry. Service industry companies usually carry small inventories
and manufacturing concerns hold large inventories. Some businesses follow the
Just-In-Time (JIT) production and purchasing methods that ensures low levels
of inventories or buffer stock.
Prepayments are sums paid in advance for services or goods that
are expected to be expensed within one year. These items fall within the definition
of current assets. Mostly services such as insurance, rent, pest control and
utilities are prepaid. Generally, prepaid expenses are not very significant
in the balance sheet.
Fixed Assets/Long-term Assets
Fixed assets are of long-term nature i.e. more than one year with a promise
of economic benefit. Investment in fixed assets is to a great extent discretionary.
The nature of business also influences the level of investment in fixed assets.
Manufacturing companies have heavy investments in fixed assets compared to a
retailer or a trading concern.
Fixed assets are broadly categorized into tangible assets, long-term investments,
intangible assets and other assets.
Tangible fixedAssets are physical assets i.e. property, plant
and equipment. These assets are backbone infrastructure of a business and extend
a support role to operations. Depending on the industry in which they operate,
the level of investment and nature of the asset base will vary. Tangible fixed
assets are depreciated except for land. The economic life is estimated and assets
are depreciated over this life. The policy of depreciation is discretionary
and guided through accounting standards.
Long-term
Investments of businesses are also part of fixed asset
portfolio. Businesses do invest outside its operations for varying reasons and
these investments are for long-term and expected to be divested in the future.
Long-term investments could be in a strategic businesses which are not consolidated
or investments in assets not used in operations. Investments in long term financial
derivatives such as bonds, long-term notes, stocks etc. also fall under this
category.
Intangible
Assets are non-physical and intangible in nature.
Common intangible assets are goodwill, patents, copyrights, brands and franchises.
A new item added to this list recently is software development cost. Intangible
items deserve attention, as these could be material in the balance sheet. Goodwill,
a common item of intangible asset arises when acquisitions take place. The amount
paid over and above the net worth or fair value of acquired business is shown
in the balance sheet of acquiring company as goodwill. This is also known as
purchased goodwill. Goodwill is amortized over the economic life that is estimated
by the management and according to the standard it should not exceed 40 years.
Other
Assets are shown commonly in balance sheets. These items
include a multitude of non current assets. Examples of other assets are; deferred
charges, advances to subsidiaries and minor properties not used in operations.
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