Understanding Current Assets on the Balance Sheet
When you look at a company's balance sheet, you'll see the classic three categories, Assets, Liabilities and Owners' Equity. The first section listed under the asset section of the balance sheet is called Current Assets. While all of the categories are important, the current portion of the assets section has a special significance.
Put simply, the current assets section of a balance sheet is where a company shows its cash and cash equivalents, and all of the other stuff that can be converted into cash within 12 months or less. Because these assets are easily turned into cash, they are sometimes referred to as liquid assets. Some of the specific items found under current assets are important enough that they justify their own explanation.
Cash and Cash Equivalents
Cash and Cash Equivalents under the current assets section of a balance sheet represents the amount of money the company has in the bank, whether in the form of cash, savings bonds, certificates of deposit, and money invested in money market funds. It tells you how much money is available to the business immediately.
One question often asked about business cash is the proper amount of cash a company should keep on its balance sheet. Generally speaking, the more cash on hand the better, though excessive amounts are likely to make investors unhappy, as they would rather have the money paid out in the form of a dividend to be reinvested, spent, saved, or given to charity.
Cash-On-Hand and Dividends
A decent amount of cash-on-hand gives management the ability to pay dividends and repurchase shares, but more importantly, it can provide extra wiggle-room if and when the company runs into any financial difficulties.
Typically, a common stock investor is going to be happiest when the stock market head down if he or she owns a large, profitable business with enormous cash reserves and little to no debt. Often, these strongly capitalized businesses can come in and take advantage of the tough financial climate, buying up competitors for a fraction of their true value.
Examples of Cash Heavy Companies
A company that has a policy of piling up large amounts of cash and cash equivalents as current assets is known to be adhering to a "fortress balance sheet" philosophy. Two examples of this are Berkshire Hathaway, a holding company here in the United States, and Nintendo, a video game company in Japan. The former routinely have $40 to $60 billion in cash on hand. The latter has so much cash parked in its current assets that even if it stopped selling products tomorrow, it could continue to pay its bills and employees for more than 100 years.
Nintendo has such a high level of current assets due to its memory of the video game industry crash during the 1980s, when nearly every video game producer was wiped out, bankrupted, and/or liquidated. Management vowed to never again allow the terror of such an industry-specific Great Depression event to threaten its solvency.
Borrowing for Balance Sheet Cash
There are some cases where cash on the balance sheet isn't necessarily a good thing. If a company is not able to generate enough profits internally, it may borrow money from the bank, and the money sitting on its balance sheet as cash may actually be borrowed money. To find out, you will have to look at the amount of debt the company has, which is shown in its balance sheet liabilities section. You probably won't be able to tell if a company is weak based on its cash balance alone. The amount of cash relative to debt payments, maturities, and cash flow needs is far more telling.
Short-Term Investments as Current Assets
These are investments that a company plans to sell quickly or can be sold to provide cash. These 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.
Such securities and assets become important when a company has so much cash sitting around that it has no qualms about tieing 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 it stuck the cash in a corporate savings account.
Not All Current Assets Are Equal
When analyzing a company balance sheet, understand that not all current assets on the balance sheet are equal. Some companies can place money in instruments such as auction-rate securities that they treat as safe cash alternatives. The market for these instruments could, in reality, dry up and it could take weeks, months, or even longer to be able to convert them back into cash.
As an investor, it pays to be wary of exposing your portfolio to a firm that has too many questionable securities under its current assets section because it could indicate a failure of managerial competence or proper oversight. In the case of auction-rate securities, the failure rate was exceedingly high, and the use of auction-rate securities as a current asset has significantly declined.