Financial metrics,how they can be used to mine data from a company's financial statements to provide valuable insight into a company's financial performance efficiency.

Fundamentals of Accounting

Module 4 Balance Sheet - Assets

Note: All slides used in this presentation directly sourced from Accounting What the Numbers Mean 10th edition by Marshall, McManus, Viele published by McGraw-Hill Irwin or created by F. Eilts

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This Module’s Focus is on Assets on the Balance Sheet

• What is the general purpose for Assets on the Balance Sheet?

• How are they used to support the business?

• If I am the leader of a business, what types of assets do I need to generate sales and grow the business?

• What should I consider when determining what level of assets to carry?

• If I am considering investing in a company, why look at Assets on their Balance Sheet?

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Typical Balance Sheet

Investor perspective: Is the company generating an acceptable return with their investments in assets (or has the company made non-value additive or low return investments)?

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Current Assets vs. Long-Term Assets Distinction

• Current assets include cash and those assets that are expected to be converted to cash or used up within one year, or an operating cycle, whichever is longer

• Long-term assets have the ability to generate revenue beyond one year • Includes items such as:

• Land

• Buildings

• Equipment

• Intangible assets

• Natural resources

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Walmart Annual Report – Balance Sheet Assets

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Cash & Marketable Securities Considerations

• Cash includes: • Coins and paper money; • Petty cash funds, • Undeposited receipts, • Money orders, and • Checking accounts

• Marketable Securities include: • Commercial paper, • U.S. Treasury securities, • Bank certificates of deposit, and • Money-market mutual funds

• Effective cash management involves: • Investing excess cash with minimal risk, • Assures the availability of adequate amounts of cash, • Avoids unnecessarily large amounts of idle cash, and • Prevents theft and fraud.

Should The Company’s Goal Be to Maximize Cash of the Balance Sheet?

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Textron 2016 Annual Report - Assets

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Spirit Aerosystems 2016 Annual Report - Assets

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Cash & Marketable Securities - Key Considerations

• Should I view Cash reported on the balance sheet in a positive light or negative light?

• How does Cash factor into some of the ratios discussed in module 2?

• Does the company have too much or too little cash?

• If the company has a significant cash balance, what do they plan to do with it?

• If the company has minimal cash, will there be a near-term liquidity problem?

• Does cash sitting on a company’s Balance Sheet help generate any ROI for an investor?

• Would you expect most companies to hold a similar % of their total assets in cash regardless of the industry in which they compete?

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Microsoft Annual Report - Assets

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Apple Quarterly Report - Assets

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Receivables – Key Considerations • The balance sheet presentation for accounts receivable is the net realizable value due from

the company’s customers – principally for items sold on credit terms and/or financed

• Net realizable value represents the amount the business expects to collect • Accounts receivable minus the allowance for bad debt account.

• Some receivables may end up not being collectable • Why?

• Customer bankruptcy • Customer disputes • Valuation disputes

• An “Allowance for Doubtful Accounts” is created to reflect the estimated amount of gross receivables that will end up being uncollectible

• “Contra” asset account • Neutralizes the impact of the impaired asset

• Notes receivable are a written promise to pay a specific amount at a specific future date. • Typically include an interest charge for use of the money during the time period of the

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Allowance for Doubtful Account Examples

Textron

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Receivables – Key Considerations

• What is the aging of the receivables?

• What is the receivables bad debt reserve as a % of gross receivables?

• What amount of bad debt write-off’s has the company taken in recent periods?

• Are there other receivables valuation adjustments/reserves?

• Does activity in receivables possibly indicate any concerns with the “quality” of the company’s recorded sales?

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Inventory Valuation Alternatives

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Inventory – Key Considerations • Inventory

• Raw Materials • Work-in-Process • Finished Goods

• Inventory valuation methods • First in, First Out (FIFO) • Last In, First Out (LIFO) • Weighted Average • Specific Identification

• Different inventory valuation methods between 2 companies will skew a comparison of inventory “efficiency” (turns, days in inventory)

• Inventory must be reported at the lower of cost or market (i.e. replacement cost)

• Errors in the amount of ending inventory have a direct dollar-for-dollar effect on cost of goods sold and net income

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Inventory – Key Considerations

• Does the company have too much or too little inventory?

• What is the aging of the inventory?

• What is the inventory write-off trend?

• Is there a potential obsolete or excess inventory issue at the company?

• What are the inventory turns and how do they compare to the company’s peers?

• How good are the company’s inventory controls? • Is it all there?

• Is there cost still in inventory that should be costed in the P&L?

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Prepaid Expense – Key Considerations

• Prepaid expenses are expenses that have been paid in the current fiscal period but will not be charged to the income statement until a subsequent fiscal period

• Typical examples: • Insurance • Rent

• As discussed during Module 1, these are examples of “reclassifications” that will occur each month to apportion the appropriate amount of expense from the balance sheet into the income statement

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Property Plant & Equipment – Key Considerations

• Includes: • Land • Buildings • Equipment • Leasehold improvements

• Other than Land, these assets are depreciated over the expected life of the asset • Credit Accumulated Depreciation • Debit Depreciation Expense on the Income Statement

• Depreciation represents an allocation of the cost of an asset to the years in which the benefits of the asset are expected to be received. It is an application of the matching concept.

• Various depreciation methods • Straight line • Declining balance • Units of production

• Note: Preventative maintenance expenditures and routine repair costs are clearly expenses of the period in which they are incurred.

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Property Plant & Equipment – Key Considerations

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Textron: “Property, Plant and Equipment Property, plant and equipment are recorded at cost and are depreciated primarily using the straight-line method. We capitalize expenditures for improvements that increase asset values and extend useful lives. Property, plant and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. If the carrying value of the asset exceeds the sum of the undiscounted expected future cash flows, the asset generally is written down to fair value. “

Property Plant & Equipment – Key Considerations

• Are the assets producing value for the company?

• What analyses does the company perform prior to initiating discretionary CapEx expenditures?

• Are the asset lives appropriate?

• How is the company depreciating these assets?

• Are there non-productive fixed assets on the balance sheet?

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Assets Acquired by Capital Lease

• An operating lease is an ordinary lease for the use of an asset that does not involve any attributes of ownership

• A capital lease results in the lessee (renter) assuming virtually all of the benefits and risks of ownership for the leased asset

• To qualify as a capital lease, the asset must achieve one of the following:

1. Transfers ownership to lessee.

2. Includes bargain purchase price.

3. Lease term is 75% of life of asset.

4. Present value of lease payments is 90% of fair value of asset.

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Intangible Assets

• Intangible assets are noncurrent assets without physical substance

• Useful life of intangible assets is often difficult to determine

• Often provide exclusive rights or privileges

• Usually acquired for operational use.

• Intangible assets are recorded at current cash equivalent cost, including purchase price, legal fees, and filing fees

• Intangible assets include: patents, copyrights, leaseholds, leasehold improvements, franchises and licenses, trademarks and trade names, and goodwill.

• Amortization is the term used to refer to the allocation of the cost of an intangible asset over its useful life. The process is similar to straight-line depreciation

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Goodwill

• Goodwill occurs when one company buys another company

• Only ‘purchased’ goodwill is an intangible asset

• Goodwill is the amount by which the purchase price exceeds the fair market value of net assets acquired.

• Goodwill is not amortized • Instead, it is tested annually for impairment

• If the book value of goodwill exceeds its fair value, an impairment loss will be recorded

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Intangibles & Goodwill Key Considerations

• Do these assets comprise a significant portion of the company’s asset base?

• What is the company’s track record in terms of achieving the targeted benefit resulting in the creation of intangibles and goodwill?

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Intangibles & Goodwill Example – Textron 2014 Acquisition of Beechcraft

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Other Long-Term Assets

• Long-term Investments

• Notes Receivables (with maturities more than a year after the balance sheet date)

• Long-term Deferred Income Tax Assets

• When any of the above assets become current, they will be reclassified to current assets

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