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

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