The balance sheet reports the financial position of an e">
GulfBase Live Support
Section: 2 Balance Sheet
Sub Section: 2 Assets
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 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 These investments are in highly liquid form or in cash equivalents and have a short maturity so that funds can be withdrawn as needed without incurring a significant loss (However, there is a transaction cost to it which is insignificant and can be ignored).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 fixed Assets 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.
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.