The Balance Sheet : Cash
September 3, 2007
Cash is the first item that usually appears under current assets, which are, generally speaking, the most liquid assets, that is, those assets most easily converted into cash. The current assets part of the balance sheet lists the assets in descending order of liquidity. Since there’s nothing more easily converted into cash then cash itself, it’s listed first. As a rule of thumb, accountants will place an asset in the current assets category if the asset is expected to be reduced to cash during the business’s operating cycle, which is the time it takes for cash to go through the business and come back as cash, as follows: starting with cash, to the purchase of raw materials, to the manufacture of finished goods, to the sale of the goods (i.e., the inventory), to the conversion of inventory to accounts receivable, and the conversion of accounts receivable back to cash when the accounts are paid.
If the business doesn’t have an operating cycle (e.g., a restaurant), an asset will be considered current if it can be expected to be reduced to cash within a year. The distinction between current assets and noncurrent fixed assets (real estate, long-term notes, etc.) is important; a business pays its bills from its current assets. On the day the Penn Central Railroad went into bankruptcy it had hundreds of millions of dollars in fixed assets but couldn’t meet its payroll!
Cash is cash, right? Not exactly. All people may be created equal, but all cash isn’t. The $270,937 in cash Houston Sash & Door had on hand on December 31, 2003, may not be freely available to it. It might have been borrowed, and the lender might have placed certain strings on its use. When you buy the business, you’ll no doubt have to comply with the limitations. Also,
accountants are given a fairly free rein to set up as few or as many accounts on the balance sheet as they choose. A different accountant may have broken out the cash account into a number of accounts, which might have disclosed that part of the cash is in the form of certificates of deposit that don’t mature for a few months.
Sellers often do certain things in their businesses to prettify their financial statements in the anticipation of selling the business. One of the things they try to do is increase the amount of cash. The easiest way to do this is by borrowing the money. This practice is somewhat daffy, since the debt will show up on the liabilities side of the balance sheet. When we look at Houston Sash & Door’s balance sheet, we see there was a substantial increase in cash on hand from year-end 2002 to 2003. We also see an increase in long-term debt (there wasn’t any on December 31, 2002) and a $10,000 increase in notes payable. Has Houston been prettifying the books?
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