Long-Term Investment Assets on the Balance Sheet
Understanding Differences Between Long-Term and Short-Term
For many new investors, cracking open a company's 10-K and reading the balance sheet is no easy feat. Thankfully, once you start to pull apart the puzzle, it becomes easier to understand how the pieces fit together. With this understanding, in time you can begin formulating your own estimates of value.
The balance sheet is divided into three parts: assets, liabilities, and equity. In all cases the assets minus liabilities equal equity. The equity of the firm is often a key measure that can provide insight to an investor on a company’s health. If a company has positive equity, it will have a better return on equity than a company with negative equity. Startup companies may have negative equity in the beginning phases of a business. The equity shows what is left for a company after paying liabilities in the event of a liquidation. The equity can also be compared with book value. If a company has negative equity it means its liabilities exceed its assets and it can be considered insolvent.
Below we will take a look at the assets portion of the balance sheet and specifically how long-term investment assets fit in.
Balance Sheet Assets
Assets like liabilities on the balance sheet are often analyzed by short-term/current and long-term. Some asset sections of the balance sheet may even break out assets by current, long-term, and other. Often the three categories under assets will be current assets, investments, and other. In any case the long-term assets are usually segregated from the short-term assets and may not always be as easily identifiable or recognizable as the current investment assets.
Defining Long-Term Investment Assets on a Balance Sheet
When you pick up an annual report or Form 10-K filing for a publicly traded business, the long-term investment assets shown on the balance sheet represent assets that a company intends to hold for more than one year. They can consist of stocks and bonds of other companies, property, equipment, and possibly Treasuries or cash equivalents in greater than one year maturities. Usually the long-term investment assets are not highly liquid and include machinery assets, property, and other depreciating assets as well as longer term investments the company chooses to hold for an extensive period of time. Long-term investment assets can also include stock in a company's affiliates and subsidiaries, or bonds.
Generally anything under assets in the balance sheet is considered an investment by the company. Current assets will include the company’s more liquid assets like cash, marketable securities, inventory, and accounts receivable. Current assets have a holding life of 12 months or less. For additional detail on just investing components of a company’s business an investor can also look at the investing section of the cash flow statement which is broken out by: operating, investing, and financing.
The long-term investment assets section of a balance sheet takes into consideration depreciation. Depreciation is an accounting schedule created by a firm’s financial management team that decreases the value of depreciating assets over the long-term. This causes long-term investment assets to decrease in value at regular intervals. Assets in stocks, bonds, and other direct investments do not decrease in value through depreciation and are usually determined at the time of reporting by their market value. Some other considerable long-term investments may also include long-term receivables and long-term inventories.
Assets that do not use a depreciation schedule will be reported in a different way.
When a firm purchases bonds or shares of common stock as an investment, the decision about whether to classify it as short-term or long-term has implications for the way those assets are valued and reported on the balance sheet.
To provide an illustration, consider an insurance company. Imagine that it buys $10,000,000 worth of corporate bonds that it intends to sell at some point in the next twelve months; a trade made as part of a larger, complex transaction. In this situation, the bonds will be classified as short-term and subject to rules requiring them to be "marked to market."
This means if the bonds decline in value to $9,000,000 in a quarter, the $1,000,000 loss must be run through the company's income statement even though the loss hasn't been realized, existing entirely on paper.
Now, imagine an alternative scenario. In this case, the bonds were acquired for $10,000,000 and the insurance company plans on holding them until maturity as a long-term investment. In this situation, the bonds could be accounted for under an "amortized cost method."
Fluctuations in the value of bonds between now and maturity don't necessarily influence the figures reported on the income statement in the same way. Instead, any premium or discount to par value is usually amortized. This results in greater stability in reported net income.
Long-term investment assets on a balance sheet are typically assets the company has made to help it sustain a successful and profitable future. In comparison, current assets are usually liquid assets that are involved in many of the immediate operational activities of the firm.
Long-term investment assets are usually tangible. Further, long-term investment assets will generally be valued on the balance sheet through either depreciation or investment writedowns. Assets such as plants and equipment will decrease in value as they age with depreciation helping to keep fair market values assigned. Long-term investments in assets such as stocks or bonds will also change in value at each reporting cycle and companies will value these assets in various ways, usually by using mark to market methodologies that represent their value.
Overall, the valuation of long-term investment assets at each reporting cycle is an important factor in accounting for the firm’s worth on the balance sheet. There are several fundamental ratios derived from these valuations that can be important for investors, two of which include return on assets and return on equity. Both of these ratios divide a company’s net income respectively by total assets and total equity.