Examining Assets


Let ‚ s examine the proportion of each type of item on the balance sheet so that you can see how you can communicate your value in helping your organization maintain its optimum balance or financial position. This section deals with assets, but the first item under assets ‚ cash ‚ will be addressed in the next chapter.

Accounts Receivable

After cash, accounts receivable (AR) is the next most liquid item on the balance sheet. Accounts receivable is what is owed to an organization by its customers.

Maintaining the appropriate amount in AR means that ABC MediCompany does not hassle its customers too early for what it allowed them to purchase on credit, yet it does collect payment quickly when it is due. If ABC does not do a good job of collecting payments when they are due, then ABC loses the opportunity to use the cash from those payments to pay its own bills or to make other necessary investments. The longer ABC is unable to collect what it is owed, the more costs it incurs to get its money and the less likely ABC is to get full payment from a customer.

 

Growth in AR should approximate growth in net sales. If AR is growing faster than net sales, then a company may not be able to convert AR into cash quickly enough to pay its other expenses. The proportion, or balance, of AR to net sales will get out of balance. This proportion is an example of how an operating ratio can be translated into a monitoring tool. In this case, the monitoring tool is known as the accounts receivable collection period. Figure 5-3 shows how the AR collection period is calculated.


Figure 5-3: Sample operating ratios.

ABC MediCompany ‚ s AR collection period is 40.2 days ‚ not bad within ABC ‚ s industry ‚ but ABC ‚ s Seniors are concerned because they know that the AR col lection period was 38.4 days at this same time last year. ABC ‚ s collection period has crept up by 1.8 days. Without more information, it is impossible to know if this trend indicates a great job by ABC ‚ s collection group in getting payments during a poor economy or if it is an indication of performance or other problems within the collections department. Either way, the AR collection period is a number that ABC ‚ s Senior management team needs to watch closely to ensure that this trend does not continue. Smart stock investors will also be watching this number to ensure that the organization does not run into trouble. Workplace learning and performance managers or vendors should watch the AR collection period in case they want to offer a intervention that will help ABC improve its cash flow.

 

Inventory

The next asset to examine and the next operating ratio monitoring tool to look at is inventory in figures 5-1 and 5-3. Like accounts receivable, the general rule is that growth in inventory should approximate growth in net sales and for the same reason. If inventory grows faster than net sales, precious cash will be tied up in inventory and unavailable to pay other expenses of the organization.

ABC ‚ s inventory on this year ‚ s balance sheet is $750,000. Now examine inventory for this same time last year. It was $990,000. Let ‚ s say that for some time, ABC ‚ s growth in inventory had been faster than its growth in net sales. In one year, however, the amount of inventory on hand has decreased by $240,000, freeing up a large amount of cash.

In the last year, ABC has made some significant investments in just-in-time (JIT) inventory management. The days inventory supply has dropped to an average of 45.6 days. This is much more in line with ABC ‚ s industry average. ABC has made a great improvement by decreasing the size of this non-cash asset relative to others on the company ‚ s balance sheet. ABC ‚ s management team hopes to reduce that number even further in the coming year. Stock investors would be happy to see this change.

 

How long an organization should be holding its inventory varies greatly by its industry. For retail establishments, inventory is the goods offered for sale to the public.

Important ‚  

If the days inventory supply is growing faster than sales, Senior executives may have trouble generating enough cash to cover expenses. They may then have to lower prices ‚ possibly to an unprofitable level ‚ or borrow at more expensive interest rates and levels of risk on the belief that future revenue is forthcoming. Customer satisfaction, employee efficiency, purchasing excellence, and information-technology-based process improvements are just a few of the things that can affect inventory and just a few of the areas WLP may be able to influence. Senior management at many organizations would be happy to hear how your WLP interventions helped decrease the amount of cash tied up in inventory.

This discussion of inventory demonstrates an important aspect of the balance sheet displayed in figure 5-1: Balance sheets are published with two columns of numbers for comparison purposes. This format allows the amount of change in an item to be easily calculated. These changes figure into the cash flow statement, which will be addressed in the next chapter.

Prepaid Expenses

After inventory, the next asset on the balance sheet is prepaid expenses. Prepaid expenses are those that must be paid for in advance of their use. Common examples include fire insurance premiums, advertising contracts such as for a year of magazine or billboard space, or quarterly machine maintenance agreements.

Like AR and inventory, prepaid expenses tie up cash. These expenses need to stay in line with what is reasonable within the industry. ABC ‚ s prepaid expenses are $200,000 and have grown from last year ‚ s amount. Given some of ABC ‚ s investments in property, plant, and equipment, increases in prepaid expenses for maintenance contracts are reasonable to expect.

Property, Plant, and Equipment

The next asset on the balance sheet is long- term assets, which, in ABC ‚ s case, consist only of property, plant, and equipment (PPE, sometimes referred to as fixed assets).

ABC MediCompany has made some significant investments in PPE (fixed assets) last year. If last year ‚ s balance sheet numbers were put into a bar graph, such as the one in figure 5-2, you would see that the size of the bar for PPE is much larger this year relative to ABC ‚ s other assets. In fact, this is what is shown in figure 5-4.

 

Figure 5-4: Year-to-year asset comparison.

Accumulated Depreciation

On the balance sheet shown in figure 5-1, you can see a line for another asset ‚ accumulated depreciation ‚ which follows PPE. Accumulated depreciation is different from other assets in that it is a write-off of a certain percentage of value from the organization ‚ s PPE assets.

Long-term assets age and eventually must be replaced . Organizations pledge their long-term assets as collateral for loans. If the organization never adjusts the amount that a long-term asset is worth, then the value of the asset, or the organization ‚ s borrowing basis, is artificially inflated. The organization would be pledging assets that were not really worth as much as the original purchase price. Depreciation allows the organization to reduce the value of the asset on their books in order to reflect a fair borrowing basis to their lenders. In figure 5-4, you can see accumulated depreciation outlined as a dotted area at the end of long-term assets. The dotted area is subtracted from the book value of PPE so that the amount of PPE is more fairly represented.




Quick Show Me Your Value
Quick! Show Me Your Value
ISBN: 1562863657
EAN: 2147483647
Year: 2004
Pages: 157

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