How to read current assets to assess financial risk

When analyzing a company’s balance sheet, investors often overlook an important component that can measure the company’s ability to survive: observing the different components of assets, especially distinguishing between assets that can be quickly converted into cash and those that may take a longer time. This difference provides valuable information for investment decisions.

The Difference Between Two Types of Assets

A company’s (Balance Sheet) divides assets into two main categories:

Current Assets are assets that the company can convert into cash or cash equivalents within a period of no more than 12 months. The key characteristic of this category is that it reflects the company’s ability to manage financial emergencies. When the company faces temporary liquidity shortages, these assets can be quickly turned over for use, such as during the COVID-19 pandemic when many companies relied on short-term assets to cover employee wages, machinery repairs, and rent.

Non-Current Assets are assets that the company must hold for a longer period, exceeding 12 months. This category emphasizes supporting long-term operations, such as land, buildings, machinery, and long-term investments. During a crisis, these assets cannot be sold quickly because the sale process takes time and is limited by market liquidity.

Main Components of Current Assets

When studying the balance sheet, investors will find that short-term assets are categorized into several groups to clarify the asset structure:

Cash and Cash Equivalents are the most liquid assets, including cash on hand, bank deposits, short-term investments, and promissory notes. The advantage is quick access, but holding cash yields no return.

Short-term Investments are investments in stocks, bonds, gold, or other assets made by some companies to generate additional income. Although riskier, they offer the potential for returns on invested funds.

Notes and Accounts Receivable are debt instruments from partners payable within one year. While they are assets, they carry the risk of default.

Trade Receivables refer to amounts owed by customers for goods or services already provided. This is important because it can be more variable than cash; if customers cannot pay, the company may face a crisis.

Inventory includes raw materials, work-in-progress, and finished goods awaiting sale. This is significant because large inventories indicate the company can convert them into cash, but excess inventory may become sunk costs.

Prepaid Expenses such as insurance, membership fees, and rent paid in advance but not yet received as services. When the time comes, they can help reduce current expenses.

Example Analysis from Apple Inc.

Apple Inc. serves as a key example in studying current assets. At the end of 2019, Apple held $59 billion in cash and cash equivalents, demonstrating strong financial health. Apple’s CEO, Tim Cook, confidently stated that cash was not an issue for Apple even in tight situations.

However, in 2020, interesting changes occurred:

Cash decreased from $90 billion to $48 billion (a 46% decrease), while trade receivables increased from $37 billion to $60 billion (an increase of 62.7%).

This shift indicates a change in Apple’s asset management policy, possibly due to more lenient collection policies or increased credit risk from partners. Investors should observe and understand these signals carefully.

What to Watch When Reading Non-Current Assets

Non-current assets are crucial for assessing the overall quality of a company’s asset structure. Investors should check:

• The proportion of non-current assets relative to total assets. A high ratio may mean a longer time to recover investments.
• The quality of these assets, such as machinery age and depreciation.
• Year-over-year changes in the value of non-current assets to identify growth trends.

Summary

Studying financial statements, especially assets, is essential for investors. Current assets help understand the company’s short-term liquidity, while non-current assets indicate long-term potential. Investors should analyze the types and sizes of each asset category carefully and monitor annual changes to make well-informed investment decisions.