Analyzing Investing Activities

Assets

Resources controlled by a company for the purpose of generating profit

Current Assets

Resources readily convertible into cash within the operating cycle of the company

Long-term Assets

Resources expected to benefit the company for periods beyond the current period

Financial Assets

Marketable securities and other investments in nonoperating assets

Operating Assets

Constitutes most of a company’s assets, valued at cost and expected to yield returns in excess of the weighted-average cost of capital

Current Assets

Operating cycle

Amount of time from commitment of cash purchases until the collection of cash resulting from sales of goods and services

Working Capital

The excess of current assets over current liabilities

Cash and Cash Equivalents

  1. Cash – the most liquid asset, currency and funds on deposit
  2. Cash equivalents – highly liquid, short-term investments, readily convertible into cash, minimal risk

Receivables

  1. Amounts due to the company from the sale of products or services
  2. Report at net realizable value

Inventories

  1. Goods held for sale
  2. Inventory valuation impacts net income and asset valuation

Long-term Assets

  1. Tangible, property, plant and equipment
  2. Intangible, patents, trademarks, copyrights and goodwill

Capitalization

  • Process of deferring a cost that is incurred in the current period, but whose benefits are expected to extend to one or more future periods
  • Putting the asset on the balance sheet rather than immediately expensing its cost in the income statement
  • Future benefits of intangible assets must be reliably measured

Effects on income

  1. Postpones the recognition of expense in the income statement
  2. Smoother income series (capital expenditures are often “lumpy”)

Effects on profitability ratios

  1. Decreases volatility in income measures
  2. Affects both numerator (income) and denominator (investment bases)
  3. Numerator is magnified while the denominator becomes smaller

Effects on solvency ratios

  1. Better solvency ratios
  2. Immediate expensing of costs understates equity for companies with productive assets

Allocation

  • Process of periodically expensing a deferred cost to one or more future expected benefit periods
  • Depreciation – tangible assets
  • Amortization – intangible assets
  • Depletion – natural resources
  • Done to match asset cost with its benefits
  • Three factors
  1. Useful life
  2. Salvage value
  3. Allocation method

Impairment

  • Process of writing down the book value of the asset when its expected cash flow are no longer sufficient to recover the remaining cost reported on the balance sheet
  • Distortions
  1. Conservative bias of long-term asset valuation downwards
  2. Large transitory effects (net income) from recognizing asset impairment

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