Accounting: Day-to-Day Balance Sheet Care and Feeding
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Language | English Language |
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we've already gone over just to drive a few points
home So no you're not having deja vu But if
that sounds good to you so we can check in
the kitchen don't get caught up in five dollar words
and fancy Where'd accounting terms When you think about basic
concepts like Can I pay my freakin bills That concept
is easy You pay your rent or you live in
your ninety three Chevy Cash management Or more broadly balance
sheet management is a big focus for accountants mainly because
if there ever isn't enough cash in the till well
that the company ends up here Okay we're cutting our
balance sheet meat with a sharp knife So let's start
at the butt steak part here First up on the
liquidity rack The current ratio Yeah keyword current as in
meaning within the next year Current ratio is a measure
of what we got against what we owe Based on
current I'ii short term assets and liabilities ones we only
have to worry about for the next year But we
have to worry about two things The ratio itself Obviously
we want more assets than liabilities and how big the
numbers are Like if we run a pastry shop and
we have one hundred grand in short term assets but
a million bucks in short term liabilities well then we're
probably like months or weeks or minutes from bankruptcy When
everyone comes to collect their bills or death or whatever
it is we eloped If the same word true of
one hundred million dollars revenue company of pretty good margins
well then met Probably not a huge deal Those numbers
were so small and weaken Digest them without a lot
of grief And no they're not good But they're not
grave inducing either Probably so what's a quote Good ratio
unquote of short term assets Short term liabilities Well one
No one is clearly dangerous But what about three toe
won a million bucks in short term assets and only
three hundred grand in short term liabilities like you have
a million dollars in cash in your handy dandy B
of a account And in total you on ly o
three hundred grand Teo pay off everything Well at least
all of your short term debts That's probably pretty good
right At least you can sleep at night And this
week anyway three to one Good one Good one Dangerous
One two three Probably dead Yeah something like that Okay
Another slab of meat Let's go for the prime rib
here Accounts receivable You know we love those Love it
Love it When people owe us money for product we've
already sold them well Most accounts receivable are short term
assets It's pretty rare to sell something and then not
be owed that dough for over a year Presumably people
will pay you within the next year You can always
count on it Note that a lot of companies carry
accounts receivable It's a net number meaning that they assume
there will be a certain number of people who are
not goingto pay the dough They Oh maybe the payers
will go bankrupt and yet end up here Maybe they'll
claim their religion tells them they're not required to pay
not allowed here Whatever the reason they're going to end
up being deadbeats So the company makes an estimated guess
as to the number that will fail to pay and
figures that number into their net calculations Usually there's some
history behind the number like in the last five years
the company average five percent bad account So if they're
actually owed one hundred million dollars well they show accounts
receivable as ninety five million having netted out five million
for the likely deadbeats All right Aki Metric you'll need
to know is accounts receivable Turnover that is you sell
something to a customer who has to pay you in
ninety days Well it's great that you made the sale
but that sale cost you liquidity and that you had
to use your precious usually scarce cash resources to buy
inventory pay people to assemble the product ship it You
deal with contracts and all that So at the moment
of sale the sale actually sucked up your cash And
you can imagine that if you were net three sixty
five instead of net ninety well you could get very
illiquid very fast with all your cash in the product
That you sold the people who aren't going to pay
you for a year So metering and measuring how quickly
your accounts receivable Hey you is a big deal and
the ratio was calculated as follows You take annual credit
sales like things not sold for cash right away like
on a credit card or I'll pay you later with
an IOU divided by accounts receivable at the beginning of
the year Okay Sochi Vocabulary concept Fact door companies use
factors when they need cash Today not later But now
a factor is essentially someone who buys in accounts receivable
So for example if you have just sold four thousand
pounds of neoprene to scuba doo for say a hundred
grand But that hundred grand won't be paid to you
for two months or so and there's a little bit
of risk to it You might want to get the
cash sooner rather than later so you'll pay pay up
for the certainty In this case a fact door would
give you a piece of paper allowing you to legally
sign over to the fact or the right to receive
that hundred thousand dollars Whenever the neoprene Byers said they
would pay for it And that factor has the same
rights you would have in going after the neoprene buyer
to collect that money In return for that piece paper
The factor might pay you in ninety eight thousand dollars
right now Today cash So you're getting two percent less
than you would have otherwise But you're getting the money
two months sooner than you would have doing Rough math
The factor for their grief is essentially making a one
percent per month or twelve percent per year Annualized return
on your money Taking a bit of risk their right
there getting that one percent a month in payment in
return for providing cash liquidity to you Yep Inventory is
a liquid asset but inventory can and probably should be
held on the balance sheet at a big discount What
the company paid for it Okay Backto our friendly lemonade
stand Suppose you bought a million cops at a dining
each And if you had to suddenly turn them into
cash Could you really get a diamond cup for them
Like really Probably not The would be buyers would smell
your desperation And there isn't a natural liquid market for
semi used cups Smart companies negotiate with their vendor's a
return policy something on the order of wealth I have
the right to send back to you half of whatever
I bought and get ninety five percent of what I
paid you No questions asked Yeah something like that And
that's our vendors talk And in accounting for all that
will you just do the math and carry the net
number or net value of that inventory on your book
But the key idea here is that inventory isn't always
liquid and often when it's converted into cash especially in
an emergency situation there's a steep discount that you pay
All right the four elements that comprise current assets or
sorry our cash securities accounts receivable and inventory Yeah Zari
So how did the current ratio even get born Well
once upon a time a current assets and a current
liability met And then they danced It was a mating
ritual where the current asset climbed on top of the
current liability and they did a calculation Yeah specifically they
created a little baby current ratio It's a cute little
bug oven accounting term which basically describes how fast we're
paying our bills relative to collecting them Let's think about
this All right If we had a ratio of one
to one that would imply that five minutes after we've
collected a bill we've paid what we owe What happens
if someone who Oh Zack's money says Sue me I
don't owe you the bill Yeah all right Well we
might win after we sue him but it'll take months
or years to go to cord and deal with lawyers
and judges and a bizarre American legal system and will
likely go bankrupt long before we collect the fourteen thousand
two hundred thirty two dollars we are owed In fact
in the real world the common tool large companies use
against smaller ones with little to no leverage our maneuvers
like this where they just hold up the back of
their hand and tell the little companies Teo you know
Reed between the lines so one to one current ratio
is bad Bad news What is a good ratio Well
think about three to one If we're analyzing a company
and we note that it pays its bills really quickly
That's a sign that the company feels great about its
cash position that it will have plenty of dough left
over at the end of the month to pay rent
and not have to work out of the back of
you know corporate pickup truck Well what about a current
ratio of twenty to one What does that mean Well
it means you have tons of current assets few current
liabilities and well does that mean there's too much money
tied up in inventory Yeah maybe We don't know We
have to think about our peer group The industry risk
volatility whole bunch other things Because why Well because ding
ding ding these numbers don't exist in a vacuum right
That is if your company has ten million dollars in
revenue with current assets of one point five billion dollars
and current liabilities of one billion dollars Well that's one
point five to one current ratio right on the edge
of bad But look at the magnitude How is it
that you have only ten million dollars of revenue and
such huge balance sheet items One tiny wrinkle to the
bad and you're dead meat There's another ratio that speaks
directly to liquidity The quick ratio not to be confused
with the nest quick ratio which is way more delicious
Well it's called the quick ratio as a reflection of
some hand out in front vendor or saying Pay me
and then you being ableto quickly pay them That works
clever well The quick ratio is all about immediate cash
That is how quickly could you come up with whatever
amount of cachet there for defensive or offensive purposes Defense
You lose a lawsuit If you agree to pay all
of it off immediately you can pay half of what
the judged amount wass agree not to appeal And well
then the lawsuit goes away Offense A competitor wants to
get out from his business a s a P Maybe
the founder is sick or in the middle of a
midlife crisis in just took delivery of his convertible red
Porsche And if you pay X dollars today ish in
cash well then you can have his business for a
steel You could buy it for half What Get it
market So we bludgeon view with what comprised current assets
cash securities accounts receivable and inventory Which of these is
not like the other Yeah inventory if you need cash
quick Well you don't wanna have to be selling inventory
to get there Selling inventory usually ain't all that quick
And while it's technically a current asset the notion of
current is broadly defined when it comes to a thousand
spare tractor treads Usually there's not even a category for
tractor treads on eBay in some Wall Street bars and
bean counter coffee counters while the quick ratio is called
the acid test But if someone quotes you acid test
I'll check to be sure they're wearing shoes It's highly
likely they attended a you know Woodstock All right Another
ratio we have think about is de esos or days
sales outstanding It is calculated as accounts receivable over sales
made on credit Poof What does that mean Well you'll
notice if you aren't asleep yet that this is sort
of the inverse ratio of the accounts receivable turnover calculation
We just did Again it's all relative A big de
eso number means that it's taking us forever to collect
our doe That's not a good sign usually but a
jet engine company might make a sale and not deliver
the full engine for like two years albeit with partial
payments made along the way so you can't compare it
to a lemonade stands CSOs right Well the basic idea
here is just that if you are collecting your bills
relatively quickly well that's good And if you're not that's
bad And in real life most financial managers pay a
lot more attention to relative trends within a company or
in industry Then they do the external world meaning that
if last quarter de esos were thirty seven and suddenly
this quarter there forty one well then Houston we may 00:11:46.679 --> [endTime] have a problem