Small Business Taxes & ManagementTM--Copyright 2020, A/N Group, Inc.
When business is booming the concentration is usually on the income statement. In difficult economic times, business owners and executives look harder at the balance sheet.
Not all assets are created equal. If you look at balance sheets for a number of different companies you'll see that there's a pattern to the way the assets are listed. Here's a typical order"
Property, plant, and equipment
You could have additional assets such as an investment in a subsidiary, or be missing one or more assets on that list. For instance, if you're on the cash method of accounting you wouldn't have a line for accounts receivable and if you're a strictly service operation you may not have any inventory. If you're a manufacturer your inventory would be broken down into raw materials, work in process, and finished goods.
Assets are listed on the balance sheet based upon how long it would take to convert them to cash. In a word, how "liquid" they are. For example, cash is instantly liquid. Marketable securities are a close second. Accounts receivable (net of an allowance for doubtful accounts) are usually converted into cash in no more than 90 days, often much less depending on your terms of sale. While not cash, the sale has been made and the customer owes you. That's a legal obligation. It's a done deal. In some economic environments you may have trouble collecting, but that should be factored into the bad debt allowance. The only risk here is that the allowance for doubtful accounts may not be large enough. How close your projection will be to the final number will depend on your analysis, but if done correctly you should be pretty close to what you'll convert to cash. Much the same is true for a note receivable. For example, you loan a supplier $20,000 so he can fix a machine to make the part you need. The loan is for six months. Assuming you've done your homework on the supplier, the risk is probably minimal because of the short term.
Inventory is riskier--and for a number of reasons. Inventory counts can be off. Pricing can be more of an problem, particularly in times of a crisis, financial or otherwise. In some cases the price of the items can decline based on soft demand, oversupply, etc. as well as items simply going out of style or through spoilage. For some businesses inventory items can be truly slow movers, taking years to sell in the normal course of business. These effects can vary widely from business to business. Some businesses turn over inventory very quickly; others can take many months. Inventory that moves quickly usually isn't as sensitive to price fluctuations. If you're counting on inventory to generate cash, you should take a close look at the stock. Of course, the reverse could also be true. Inventory could be understated, either in the number of items or the current price, in stock.
Prepaid expenses include expenses that have been paid before they're actually used by the business. The classic example may be prepaid insurance. A company has to pay for the policy six months or sometimes a year in advance. If, on November 1, 2020 the company pays an insurance invoice that covers the period from November 1 to October 31, 2021 and the company is on a calendar, it has 10 months of prepaid insurance on its December 31, 2020 balance sheet.
Fixed assets may take time to turn into cash, and the liquidation value can be less than the carrying value on the balance sheet. Those assets can also be more valuable. A lightly used small truck may be fully depreciated over five years, but still be worth over half of the original price. The speed of a sale of equipment unique to a market will depend on the market size, making a sale difficult at a reasonable price.
The sale of a building can take considerable time. While there's a good chance you'll get more than the book value, the selling price will depend on the local market and the demand in general.
Keep in mind that the sale of fixed assets can generate a tax loss or a tax gain. A fully depreciated pickup truck sold for $20,000 will produce $20,000 of taxable income. The sale of a building can have several different tax consequences. But most businesses are unlikely to have good results this year so that gain may be taxed at favorable rates.
There's a host of other assets that may be carried on the balance sheet, but generally they are expenses that can't be deducted immediately for accounting or tax purposes. For example, the cost of obtaining a patent, goodwill from an acquistion, the cost of acquiring a customer list, etc. They may be hard to convert to cash as well as hard to value. That customer list may be worth much more, or much less, than what you paid for it. And coming up with a value can be difficult.
Copyright 2020 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536
--Last Update 06/02/20