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Balance Sheet 101: Understanding assets

Let's delve deeper into the assets part of the balance sheet to understand what it communicates and how to make use of it

Balance Sheet 101: Understanding assets

The asset side of a balance sheet, as the name indicates, is just a list of all the valuable items owned by a company. But it is generally classified into two broad categories - current and non-current assets.

Current assets
In layman's terms, the key feature of current assets is that these assets can be converted into cash easily. Therefore, items like bank balances, fixed deposits, liquid funds and other short-term investments are usually classified as current assets. Besides, those assets that are primarily held for trading purposes and expected to be converted into cash in the normal operating cycle fall into this category. These include items like inventory, trade receivables, etc.

Uses of current assets
The current assets section of a balance sheet is designed to help the reader understand how easy or difficult it is for the company to carry out its day-to-day operations. Since borrowing money is a costly and time-consuming process, it is important for a company to have a sufficient amount of liquid assets to conduct its day-to-day operations. Especially during economic uncertainty when banks become more risk-averse and are unwilling to give loans, having liquid assets holds more importance for a company.

So, at the very least, investors need to make sure that there is sufficient cash for running the company for two-three months. In fact, you can find the amount of cash available with a company on the website of Value Research. Once you search for a company, the amount of cash is given on the right-hand side under the table 'Key Facts'.

Let's take the example of SpiceJet and Indigo airlines. What separates these two airlines is that while SpiceJet has only Rs 42 crore of cash, Indigo has more than Rs 20,000 crore. So, given this, investors can be more certain about Indigo's ability to continue flying than SpiceJet, which may face difficulties making payments as and when they come due (fuel vendors, parking charges, salaries, etc.)

Accounts/trade receivables: An important element to watch out
This term refers to the amount that is due from customers of a company. This situation arises when a company doesn't receive money immediately after selling its products and services. Its customers are normally given some time, say between one-three months, for making the payment.

Investors have to monitor this number to ensure that it is not going up at a very fast pace. Even though giving credit is not an unhealthy trade practice, customers' creditworthiness should be taken into account. It is okay if the account's receivable goes up slightly, owing to certain seasonal fluctuations, but if it increases at a fast pace, it is likely that the company is being very aggressive in its sales efforts, which is a potential cause of worry.

Non-current assets
Any asset that does not fall into the definition of current assets is classified as non-current assets. Usually, the bulk of a company's operating assets are classified as non-current assets. Factories, land, plant and equipment all normally fall into this category. Since they are long-term assets, it is expected that they would take more time to sell. Therefore, it would be difficult for a company to immediately raise money without perhaps, giving a substantial discount.

Investors may also find that a particular asset class may fall into both categories. For example, an FD which matures in the next month would be classified as current assets, but if the same FD matures only after five years, then it would be classified as a non-current asset.

Uses of non-current assets
The non-current assets give us a much better understanding of a company's business. Since non-current assets are used for running a company's operations, it reflects its underlying business. For example, the type of assets owned by a cement-manufacturing company, such as UltraTech Cement (factories, land, mines, furnaces, etc.) would be very different from those owned by a media company, such as intellectual property, studios, etc.

While reading the asset side of a balance sheet can be useful for other purposes, it should not be forgotten that at the end of the day, it is still a simple list.

Other articles in this series
Balance sheet 101: Introduction