There is one market where you should not enter if you don't know how the market works. What to buy and at what price? More importantly, what not to buy? We are talking about the stock market. It is very important for you as a retail investor that before you put any substantial money in the market you understand the basics. In this article, we are going to talk about a very basic concept - Assets.
What is an asset?
In a layman's term, an asset is an item owned by a person, a company or a country that is regarded as having value. Since we are talking about stocks, let us try and understand assets from that perspective. An asset for a company is something which in the future can generate cash flow, improve sales and reduce expenses regardless of the kind of business the company is doing. Assets are reported in every company’s balance sheet which is made public every quarter.
Types of assets
Assets are broadly divided into two categories - current assets and non-current assets. Current assets are expected to be consumed by a company within one year, while non-current assets (also known as long term assets) are expected to continue to be productive for a company for more than one year. The different types of non-current assets are:
- Tangible fixed assets - such as building, furniture, land, vehicles, etc
- Intangible fixed assets - such as trademarks, copyrights and patents
We are going to discuss the current assets in detail in this article. The balance sheet of any company consists of three categories, assets, liabilities and owner's equity. In the asset section, the first sub-section (in some cases the second sub-section) you see on the balance sheet shows current assets. These assets can easily be converted into cash and hence they are also referred to as liquid assets.
Having more current assets than liabilities indicates that a company should be able to meet its short-term obligations. The different current assets are:
Cash and Cash Equivalents - This section of a balance sheet tell you the amount of money the company holds in its bank account - it could be in a form of cash, certificates of deposit, saving bonds or money invested in money market funds. Since all of these can be sold quickly, it tells you how much money the business can accumulate on an immediate basis, if the need arises.
How much cash should a company have on its balance sheet for you to decide to invest in the company? Well, the more cash the better it is. Although, companies don't usually sit with a large amount of cash - in most cases they give the money in a form of dividend or reinvest the money for business expansion. Some companies with high cash reserves are Coal India, Infosys and ITC.
Short Term Investment - These are investments which company can sell quickly in case there is a need for cash. As mentioned, companies usually don't like to sit with a lot of cash in their current accounts, instead, invest the money in assets and securities and tie it up with slightly long term investment options like bonds with maturities of less than a year. This gives the company a good percentage return when compared to the cash sitting in the corporate current/saving accounts.
Account Receivable - If a company is expecting outstanding money to be paid to it from its clients or customers in the near future (less than a year), the amount will come under Accounts Receivable. These are repayment of loans or credit given by the company to its clients.
Inventory - It refers to the raw material or goods a company has on hand that it can use or sell in the near future. It is important for a business to maintain a certain level of inventory to run its business, but neither low nor high levels of inventory are desirable by an investor.
A company may use different accounting methods to inflate inventory, and, at times, it may not be as liquid as other current assets depending on the product and the industry sector.
Prepaid Expenses - They are future expenses that have been paid by the company in advance. You can understand it as a cost that has been paid but not yet used up. An example of prepaid expense is the six-month insurance premium a company pays in advance for insurance coverage on a company's vehicles.
On a company’s balance sheet, current assets are normally given in order of liquidity meaning the items that can be most easily or likely to be converted into cash are ranked higher.
Real-world example - Current assets of Reliance Industries
Now you know different types of current assets, now let us analyze an actual balance sheet and see the numbers. You can find a balance sheet of any company on their website or some market related third party website like Moneycontrol. We are going to see the balance sheet of Reliance Industries. You can see the balance sheet of Reliance Industries here -
In the assets section, you will see two main categories we discussed - non-current and current assets. Under current assets, you can see the assets we discussed above - Inventories that the company holds as of 31st March 2020 stands at 38,802 crores. The investments are 70,030 crores, trade receivables are 7483 crores and so on. The total current assets are 1,66,567 crores which are higher compared to last year which was 1,52,864 crores.
Importance of Current Assets
For a company's management, the total current assets figure is very important with regard to the daily operations of a business. Investors and creditors keep a close eye on the current assets of a company to assess the value and risk involved in its operations.
In the next article, we are going to talk about non-current assets and see one more popular company’s balance sheet.