Assets

Assets are things of value owned or in some cases controlled by a company. Assets consist of those items that make up the available resources of the company. On a Balance Sheet, assets are listed in the order of their liquidity.  Liquidity refers to the ease with which assets can be converted into cash. Assets that are expected to be converted into cash in the ordinary course of business within one year are classified as current assets.

Current assets are the primary consideration in credit analysis because it is generally from current assets that a customer pays its bills. In other words, current assets are converted into cash, and that cash is used to pay current liabilities, including debts owned to trade creditors.  The current asset that credit professionals are most familiar with is accounts receivable. Accounts receivable are funds owed to the business by its customers. Generally, accounts receivable are listed on a balance sheet at their stated value minus a reserve for discounts and bad debts.

A capital asset is any type of assets owned by a company with an estimated useful life of more than one year.

Inventory, sometimes broken down into raw materials, work in process, and finished goods inventory is less liquid than accounts receivable. In order for inventory to be converted into cash, it must be converted from raw materials inventory to finished goods inventory, made available for sale, and sold.  The process of selling often involves the creation of an accounts receivable, which upon collection by the creditor becomes cash available to the creditors. Accounts receivable is collected from the buyer (based on the seller's terms of sale) and only at this point and after each of these steps is the process of converting inventory into cash completed.

A credit analyst must always consider the possibility that the a debtor will file for bankruptcy protection. An analysis of the debtor's assets is the first step in the process of trying to determine how much might be available to satisfy the debts owed by the debtor company.  Cash has 100% liquidation value.  Accounts receivable may be difficult to collect by a debtor that has filed bankruptcy. Creditors generally assume the debtor will collect no more than 80 cents on the dollar on their accounts receivable and may have trouble collecting much more than 50 cents on the dollar.

As a rule of thumb, creditors should assume that debtors will get 50% or less of of the stated value of inventory in a liquidation. Even this figure could be too optimistic.  It is more difficult to guage the liquidation value of a company's non-current assets which would include property, plant and equipment.  Most non-currents assets are carried on the debtor's books at their acquisition cost minus accumulated depreciation. The market value of non-current assets may have very little in common with the values listed on the balance sheet.

Following fixed assets are such items as prepaid expenses (such as insurance premiums paid in advance), miscellaneous assets (such as receivables from officers or employees), and intangible assets (such as research or organization expenses deferred to future operations). In the event of liquidation the fixed assets would have some value, but most prepaid expenses and intangible assets would probably be worth nothing at all. However, there exceptions. In some cases, intangible assets are of significant value. For example, a tradename such as Coca-Cola ® obviously has a substantial value to the Coca-Cola Bottling Company and would have a significant value int he extremely unlikely event that this corporation failed and the assets of the corporation were sold in a liquidation process.

All of these issues make any attempt by a creditor to estimate the liquidation value of the assets of a company a difficult and inexact process.

© 2009 by Michael C. Dennis.  All Rights Reserved.