The Balance Sheet: Part 1. Assets - Chapter 3 - Finance for Non-Financial Managers

This post is part of the Finance for Non-Financial Managers book series of posts, which is the first subset of posts in the larger PMBA series of posts. You can buy Finance for Non-Financial Managers from the author Gene Siciliano for $14.95.

This chapter seems a bit longer than the previous two, and a quick skimming of the chapter subtitles reveals that it will be a step down into the Accounting technical weeds. Armed with this knowledge, I’m going to take another hint from How to Read a Book and start by reading the chapter summary, so I am aware of the chapter’s main points before I read them in the chapter itself.

5 Summary Points

•  The balance sheet is a point-in-time report highlighting a company’s cash management, profitability, and adequacy of invested capital.
• current assets (+) and current liabilities (-) are related in that both have a shelf life of 12 months. Current assets are used to pay for current liabilities, and the difference between the two is called net working capital.
• Collectibility is the most important aspect of an accounts receivable; a customer-by-customer review is in order to understand its quality.
• Inventory can be a high risk for the business if management practices don’t guard against the inventories deterioration, obsolescence and breakage.
• Delaying payment of their accounts payable, cash strapped businesses can find a temporary way to make it through the day-to-day. Shhh!… don’t tell their creditors.

The 5 points above were summarized from Finance for Non-Financial Managers.

The Chapter starts by introducing you to the Wonder Widget Company and their balance sheet. Assets and liabilities/stock holder’s equity, the two sides of the balance sheet, balance. The chapter proceeds by going through the balance sheet line-by-line.

The first sub category on the assets side of the balace sheet is called the CURRENT ASSETS and has the following line items listed under it:

• cash and equivalents,
• accounts receivable,
• allowances for bad debt,
• inventory and
• prepaid expenses.

The sub heading of cash and equivalents holds the value of all assets that could be used to pay off debts in a short amount of time (usually within 1 year). Savings accounts, certificates, and money market accounts are all examples of the values that would be summed to give you a sub total under cash and equivalents. Accounts receivable displays money that is owed by customers that is expected to be paid back within the next 12 months. Other then customer accounts that will be received throughout the year, businesses may also be expecting to be repaid for loans made to their employee, or they may be expecting a tax refund. The sub heading “allowance for bad debts” refers to those debts that are outstanding, that the company is stating will not be paid back. These are not usually specific sales that the company does not think it will be paid back, rather the number usually reflects a percentage of sales that the company thinks is likely not to be paid back, generically speaking. The self-explanatory inventory sub heading is further broken down into raw materials, works in progress and finished goods. It is interesting to note that under finished goods, amounts for factory rent, and labor are represented within this line item. Prepaid expenses are unique in the Current Assets sheet in that they are the only items that will not be converted into cash within the next 12 months. The prepaid expenses item is there to record cash set aside for insurance payments, as well as tax liability payments.

FIXED ASSETS are different from current assets in that they were not purchased with the idea* of selling them in the future for a profit. Rather, fixed assets are bought and used, usually until their value becomes $0, and then they are replaced. Under the fixed assets sub-heading, the values of the fixed assets are subtotaled, and then the accumulated depreciation is subtracted.

The final category, OTHER ASSETS are for miscellaneous items that do not fit in neither the current assets nor the fixed assets. Examples of other assets might be deposits that are currently being held by others, as well as long-term investments made on behalf of the company.

Next the chapter discusses the Liabilities/Owner’s Equity side of the balance sheet.

* the phrase “with the idea” is inserted here, because although land is not bought as a part of a regular business with the intent to make a profit, land usually increases in value, and therefore can be sold for a profit.