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Accounting: Day-to-Day Balance Sheet Care and Feeding 0 Views


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00:00

Accounting Allah shmoop Day today Balance sheet care and feeding

00:08

Okay people So let's put some mathematical meat on the

00:11

bones of our balance sheet and map a means for

00:14

viewing liquidity Well some of this may feel familiar It's

00:18

going to be a slightly similar ish take on what

00:21

we've already gone over just to drive a few points

00:23

home So no you're not having deja vu But if

00:26

that sounds good to you so we can check in

00:28

the kitchen don't get caught up in five dollar words

00:31

and fancy Where'd accounting terms When you think about basic

00:34

concepts like Can I pay my freakin bills That concept

00:37

is easy You pay your rent or you live in

00:40

your ninety three Chevy Cash management Or more broadly balance

00:45

sheet management is a big focus for accountants mainly because

00:48

if there ever isn't enough cash in the till well

00:51

that the company ends up here Okay we're cutting our

00:54

balance sheet meat with a sharp knife So let's start

00:57

at the butt steak part here First up on the

01:01

liquidity rack The current ratio Yeah keyword current as in

01:05

meaning within the next year Current ratio is a measure

01:09

of what we got against what we owe Based on

01:12

current I'ii short term assets and liabilities ones we only

01:16

have to worry about for the next year But we

01:17

have to worry about two things The ratio itself Obviously

01:21

we want more assets than liabilities and how big the

01:24

numbers are Like if we run a pastry shop and

01:27

we have one hundred grand in short term assets but

01:29

a million bucks in short term liabilities well then we're

01:33

probably like months or weeks or minutes from bankruptcy When

01:37

everyone comes to collect their bills or death or whatever

01:39

it is we eloped If the same word true of

01:42

one hundred million dollars revenue company of pretty good margins

01:46

well then met Probably not a huge deal Those numbers

01:49

were so small and weaken Digest them without a lot

01:51

of grief And no they're not good But they're not

01:54

grave inducing either Probably so what's a quote Good ratio

01:59

unquote of short term assets Short term liabilities Well one

02:02

No one is clearly dangerous But what about three toe

02:05

won a million bucks in short term assets and only

02:08

three hundred grand in short term liabilities like you have

02:12

a million dollars in cash in your handy dandy B

02:14

of a account And in total you on ly o

02:17

three hundred grand Teo pay off everything Well at least

02:21

all of your short term debts That's probably pretty good

02:23

right At least you can sleep at night And this

02:25

week anyway three to one Good one Good one Dangerous

02:28

One two three Probably dead Yeah something like that Okay

02:31

Another slab of meat Let's go for the prime rib

02:33

here Accounts receivable You know we love those Love it

02:36

Love it When people owe us money for product we've

02:39

already sold them well Most accounts receivable are short term

02:43

assets It's pretty rare to sell something and then not

02:46

be owed that dough for over a year Presumably people

02:49

will pay you within the next year You can always

02:51

count on it Note that a lot of companies carry

02:54

accounts receivable It's a net number meaning that they assume

02:57

there will be a certain number of people who are

02:59

not goingto pay the dough They Oh maybe the payers

03:02

will go bankrupt and yet end up here Maybe they'll

03:05

claim their religion tells them they're not required to pay

03:09

not allowed here Whatever the reason they're going to end

03:12

up being deadbeats So the company makes an estimated guess

03:15

as to the number that will fail to pay and

03:18

figures that number into their net calculations Usually there's some

03:22

history behind the number like in the last five years

03:24

the company average five percent bad account So if they're

03:27

actually owed one hundred million dollars well they show accounts

03:30

receivable as ninety five million having netted out five million

03:35

for the likely deadbeats All right Aki Metric you'll need

03:38

to know is accounts receivable Turnover that is you sell

03:42

something to a customer who has to pay you in

03:45

ninety days Well it's great that you made the sale

03:47

but that sale cost you liquidity and that you had

03:51

to use your precious usually scarce cash resources to buy

03:55

inventory pay people to assemble the product ship it You

03:59

deal with contracts and all that So at the moment

04:01

of sale the sale actually sucked up your cash And

04:05

you can imagine that if you were net three sixty

04:08

five instead of net ninety well you could get very

04:11

illiquid very fast with all your cash in the product

04:15

That you sold the people who aren't going to pay

04:17

you for a year So metering and measuring how quickly

04:19

your accounts receivable Hey you is a big deal and

04:22

the ratio was calculated as follows You take annual credit

04:25

sales like things not sold for cash right away like

04:28

on a credit card or I'll pay you later with

04:30

an IOU divided by accounts receivable at the beginning of

04:34

the year Okay Sochi Vocabulary concept Fact door companies use

04:39

factors when they need cash Today not later But now

04:43

a factor is essentially someone who buys in accounts receivable

04:47

So for example if you have just sold four thousand

04:49

pounds of neoprene to scuba doo for say a hundred

04:52

grand But that hundred grand won't be paid to you

04:54

for two months or so and there's a little bit

04:57

of risk to it You might want to get the

04:59

cash sooner rather than later so you'll pay pay up

05:02

for the certainty In this case a fact door would

05:05

give you a piece of paper allowing you to legally

05:07

sign over to the fact or the right to receive

05:10

that hundred thousand dollars Whenever the neoprene Byers said they

05:13

would pay for it And that factor has the same

05:16

rights you would have in going after the neoprene buyer

05:19

to collect that money In return for that piece paper

05:21

The factor might pay you in ninety eight thousand dollars

05:25

right now Today cash So you're getting two percent less

05:28

than you would have otherwise But you're getting the money

05:31

two months sooner than you would have doing Rough math

05:34

The factor for their grief is essentially making a one

05:37

percent per month or twelve percent per year Annualized return

05:42

on your money Taking a bit of risk their right

05:44

there getting that one percent a month in payment in

05:47

return for providing cash liquidity to you Yep Inventory is

05:51

a liquid asset but inventory can and probably should be

05:54

held on the balance sheet at a big discount What

05:56

the company paid for it Okay Backto our friendly lemonade

05:59

stand Suppose you bought a million cops at a dining

06:02

each And if you had to suddenly turn them into

06:04

cash Could you really get a diamond cup for them

06:07

Like really Probably not The would be buyers would smell

06:11

your desperation And there isn't a natural liquid market for

06:14

semi used cups Smart companies negotiate with their vendor's a

06:18

return policy something on the order of wealth I have

06:21

the right to send back to you half of whatever

06:23

I bought and get ninety five percent of what I

06:26

paid you No questions asked Yeah something like that And

06:29

that's our vendors talk And in accounting for all that

06:32

will you just do the math and carry the net

06:34

number or net value of that inventory on your book

06:38

But the key idea here is that inventory isn't always

06:41

liquid and often when it's converted into cash especially in

06:45

an emergency situation there's a steep discount that you pay

06:48

All right the four elements that comprise current assets or

06:51

sorry our cash securities accounts receivable and inventory Yeah Zari

06:58

So how did the current ratio even get born Well

07:01

once upon a time a current assets and a current

07:04

liability met And then they danced It was a mating

07:08

ritual where the current asset climbed on top of the

07:11

current liability and they did a calculation Yeah specifically they

07:16

created a little baby current ratio It's a cute little

07:19

bug oven accounting term which basically describes how fast we're

07:22

paying our bills relative to collecting them Let's think about

07:25

this All right If we had a ratio of one

07:27

to one that would imply that five minutes after we've

07:30

collected a bill we've paid what we owe What happens

07:33

if someone who Oh Zack's money says Sue me I

07:36

don't owe you the bill Yeah all right Well we

07:39

might win after we sue him but it'll take months

07:41

or years to go to cord and deal with lawyers

07:44

and judges and a bizarre American legal system and will

07:47

likely go bankrupt long before we collect the fourteen thousand

07:50

two hundred thirty two dollars we are owed In fact

07:53

in the real world the common tool large companies use

07:56

against smaller ones with little to no leverage our maneuvers

07:59

like this where they just hold up the back of

08:01

their hand and tell the little companies Teo you know

08:04

Reed between the lines so one to one current ratio

08:07

is bad Bad news What is a good ratio Well

08:10

think about three to one If we're analyzing a company

08:13

and we note that it pays its bills really quickly

08:15

That's a sign that the company feels great about its

08:18

cash position that it will have plenty of dough left

08:21

over at the end of the month to pay rent

08:23

and not have to work out of the back of

08:25

you know corporate pickup truck Well what about a current

08:27

ratio of twenty to one What does that mean Well

08:30

it means you have tons of current assets few current

08:33

liabilities and well does that mean there's too much money

08:37

tied up in inventory Yeah maybe We don't know We

08:39

have to think about our peer group The industry risk

08:42

volatility whole bunch other things Because why Well because ding

08:47

ding ding these numbers don't exist in a vacuum right

08:49

That is if your company has ten million dollars in

08:51

revenue with current assets of one point five billion dollars

08:55

and current liabilities of one billion dollars Well that's one

08:59

point five to one current ratio right on the edge

09:02

of bad But look at the magnitude How is it

09:05

that you have only ten million dollars of revenue and

09:07

such huge balance sheet items One tiny wrinkle to the

09:11

bad and you're dead meat There's another ratio that speaks

09:14

directly to liquidity The quick ratio not to be confused

09:18

with the nest quick ratio which is way more delicious

09:21

Well it's called the quick ratio as a reflection of

09:23

some hand out in front vendor or saying Pay me

09:27

and then you being ableto quickly pay them That works

09:30

clever well The quick ratio is all about immediate cash

09:33

That is how quickly could you come up with whatever

09:36

amount of cachet there for defensive or offensive purposes Defense

09:40

You lose a lawsuit If you agree to pay all

09:42

of it off immediately you can pay half of what

09:45

the judged amount wass agree not to appeal And well

09:48

then the lawsuit goes away Offense A competitor wants to

09:51

get out from his business a s a P Maybe

09:54

the founder is sick or in the middle of a

09:56

midlife crisis in just took delivery of his convertible red

10:00

Porsche And if you pay X dollars today ish in

10:03

cash well then you can have his business for a

10:06

steel You could buy it for half What Get it

10:09

market So we bludgeon view with what comprised current assets

10:12

cash securities accounts receivable and inventory Which of these is

10:16

not like the other Yeah inventory if you need cash

10:20

quick Well you don't wanna have to be selling inventory

10:23

to get there Selling inventory usually ain't all that quick

10:26

And while it's technically a current asset the notion of

10:29

current is broadly defined when it comes to a thousand

10:32

spare tractor treads Usually there's not even a category for

10:35

tractor treads on eBay in some Wall Street bars and

10:38

bean counter coffee counters while the quick ratio is called

10:41

the acid test But if someone quotes you acid test

10:45

I'll check to be sure they're wearing shoes It's highly

10:47

likely they attended a you know Woodstock All right Another

10:50

ratio we have think about is de esos or days

10:53

sales outstanding It is calculated as accounts receivable over sales

10:58

made on credit Poof What does that mean Well you'll

11:01

notice if you aren't asleep yet that this is sort

11:03

of the inverse ratio of the accounts receivable turnover calculation

11:07

We just did Again it's all relative A big de

11:09

eso number means that it's taking us forever to collect

11:13

our doe That's not a good sign usually but a

11:16

jet engine company might make a sale and not deliver

11:18

the full engine for like two years albeit with partial

11:21

payments made along the way so you can't compare it

11:23

to a lemonade stands CSOs right Well the basic idea

11:26

here is just that if you are collecting your bills

11:29

relatively quickly well that's good And if you're not that's

11:32

bad And in real life most financial managers pay a

11:34

lot more attention to relative trends within a company or

11:37

in industry Then they do the external world meaning that

11:41

if last quarter de esos were thirty seven and suddenly

11:43

this quarter there forty one well then Houston we may 00:11:46.679 --> [endTime] have a problem

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