Current Assets on the Balance Sheet
By Joshua Kennon. Investing for Beginners Expert
Thanks to his straight-forward approach and ability to simplify complex topics, Joshua Kennon's series of lessons on financial statement analysis have been used by managers, investors, colleges and universities throughout the world. "If an investment idea takes more than a few sentences, or cannot be explained to a reasonably intelligent fourth grader, you've moved into speculation," Joshua insists. "Whether you're dealing with a public company such as McDonald's, or a private company such as Chanel, these are the types of firms that are easy to understand. You know where the sales originate, what the costs are, and how profits are generated. These are the types of enterprises that aren't going to cause you to wake up in the middle of the night, breaking into a cold sweat because of the sub-prime crisis or esoteric securities trading in illiquid markets. That's a huge advantage to growing your wealth. Focus on what you know, pay a fair price, and invest for the long-term.
Let's take a moment to examine each.
Cash and Cash Equivalents
Not only does a decent cash hoard give management the ability to pay dividends and repurchase shares. but it can provide extra wiggle-room when times get bad. Typically, a common stock investor is going to be happiest when the stock market falls apart if he or she owns a large, profitable business with large cash reserves and little to no debt. Often, these strongly capitalized businesses can swoop in and take advantage of the maelstrom, buying up competitors for a fraction of their true value, or expanding market share as others in the industry are busy playing defense.
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If a company is not able to generate enough profits internally, they may turn to a bank 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 look at the amount of debt a company has (we will be discussing this later on in the lesson). The moral: You probably won't be able to tell if a company is weak based on cash alone;
the amount of debt is far more important.
Short Term Investments on the Balance Sheet
These are investments that the company plans to sell shortly or can be sold to provide cash. Short term investments aren't as readily available as money in a checking account, but they provide added cushion if some immediate need were to arise. These securities and assets 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 higher interest rate than if they stuck the cash in a corporate savings account.
From time to time, companies become known for their legendary cash hoards. A decade ago, Microsoft was known for its $5.25 billion in cash and $32.973 billion in short term investments. Berkshire Hathaway has kept as much as $40+ billion in cash on hand as a strategic maneuver to allow its legendary Chairman of the Board and Chief Executive Officer, Warren Buffett. the opportunity to pounce on deeply discounted stocks and entire enterprises during recessions or depressions. Almost all of these funds are kept in short-term Treasury bills, representing a claim on the taxing power of the United States Government.
Not All Current Assets Are Equal
As an investor, you need to understand not all current assets on the balance sheet are equal. Many companies are now holding things called "auction rate securities ", which they treat as a high quality current asset when they clearly aren't - in a panic, the market for these will dry up and it could take weeks, months, or even longer to convert back into greenbacks. You need to dig into the 10K or annual report and find out the specific type of holding in which management has placed your money.
This page is part of Investing Lesson 3 - Understanding the Balance Sheet. To go back to the beginning, see the Table of Contents . If you have already read this lesson, you can skip directly to the Balance Sheet Quiz .Source: beginnersinvest.about.com