Understanding assets
The answer
An asset is something a company controls that is expected to bring in money later. The balance sheet lists them in a fixed order, from the ones that turn into cash soonest to the ones that may never turn into cash at all.
The order is the warning. The further down the list a number sits, the more of it is somebody's estimate.
Why this costs you money
A company reports total assets of ₹12,000 crore. That sounds like a solid business with real things behind it.
Then you look at what those assets are. ₹4,100 crore is goodwill, an accounting entry created when the company bought another company for more than its net assets were worth. ₹2,900 crore is trade receivables, money customers owe and have not paid. ₹1,800 crore is inventory, stock in warehouses that nobody has agreed to buy. ₹400 crore is cash.
Of ₹12,000 crore of "assets", the amount that is definitely money is ₹400 crore.
Here is the specific way this costs money. Receivables and inventory are the 2 lines where a struggling company hides a problem, because both make profit look good while cash gets worse.
If a company cannot sell its product, it can offer very long payment terms to win the order. Revenue is recorded. Profit rises. Receivables grow. If a product stops selling, the company can keep the unsold stock on the books at cost instead of writing it down. Profit stays high. Inventory grows.
Both are visible from outside, in the published accounts, using arithmetic you can do on a phone. Almost nobody does it. That is the opportunity in this article.
How it works
Assets are split twice: once by time, once by whether you can touch them.
Current and non-current
Current assets are expected to become cash within 12 months. Non-current assets are held longer.
Indian balance sheets under Schedule III list non-current first, then current. American balance sheets usually list current first. The contents are the same.
The list, from most certain to least
Cash and cash equivalents. Money in the bank and deposits maturing within 3 months. The most certain number on the page, assuming it exists.
Other bank balances. Deposits held longer, or deposits pledged against a loan. Read the note. Pledged cash is not available to the company.
Trade receivables. Money owed by customers for goods already delivered. The notes split it by how overdue it is. That ageing table is one of the 3 most useful tables in an annual report.
Inventories. Raw materials, work in progress and finished goods, valued at the lower of cost and net realisable value. That rule matters: the company must write inventory down if it cannot sell it for at least what it cost. Whether it does so on time is a judgement.
Loans and advances. Money the company has lent out. If a large amount is lent to related parties — companies owned by the same family or group — that is money that has left the business.
Property, plant and equipment, often shortened to PPE. Land, buildings, machines. Recorded at cost, reduced each year by depreciation, which spreads that cost over the asset's expected life. The remaining figure is called the carrying value or net block. It is not the resale value.
Capital work in progress, or CWIP. A factory being built. It sits here, producing nothing, until it is finished and moves to PPE. A CWIP figure that stays large for 4 years is a project that is not finishing.
Goodwill. Created only when one company buys another for more than the fair value of the acquired company's net assets. It represents what the buyer paid for things it could not name: customer relationships, the brand, the team. It cannot be created internally.
Other intangible assets. Patents, licences, software, brands and customer lists that were purchased. Amortised over their useful life, which is the same idea as depreciation with a different word.
Deferred tax assets. A future tax saving expected because of past losses or timing differences. Worth something only if the company earns enough profit later to use it.
The one rule about goodwill
Goodwill is not depreciated. It is tested every year and written down if the business it came from is worth less than the price paid. That write-down is called an impairment.
Management decides when to admit the acquisition was too expensive, and there is pressure to delay, because an impairment reduces reported profit and equity in one line. So goodwill impairments tend to arrive late, in bad years, and in large amounts. A company whose goodwill is a large share of total assets and has never been impaired may have an unrecorded loss waiting.
What it tells you, and what it does not
Assets tell you what the company has to work with, and how much of that is money as opposed to expectation.
They do not tell you what anything is worth today. A profitable 25-year-old plant may be carried at almost nothing. A useless 3-year-old plant may be carried at 80% of cost. The balance sheet cannot distinguish them and does not try to.
They do not include self-built value. A company that spent 40 years building a trusted name has nothing on the balance sheet for it. A company that bought that same name last year carries it as an intangible asset. Two identical businesses, 2 very different asset totals.
And a large asset base is not automatically good. Every rupee of assets was paid for by a lender or a shareholder, and both expect a return. A business that produces the same profit from half the assets is the better business.
The decision rule
Judge assets by how fast they convert, not by how large they are.
If receivable days and inventory days are stable or falling while revenue grows, the growth is real and it is converting into money. If either measure rises for 3 consecutive years while revenue grows, treat the revenue growth as unproven — unless the company has deliberately entered a business with longer payment terms and has said so, in which case the step up should happen once and then stop.
Try this now
Twenty minutes, on 1 holding, and it will change how you look at every company after this. You are going to convert 2 balance sheet numbers into days.
- Open the latest annual report for 1 holding, and also the annual report from 3 years earlier. Both are on the company's Investors page, or on EDGAR for an American company. You need 2 documents.
- From the latest report, write down 4 numbers: revenue and cost of goods sold from the income statement, and trade receivables and inventories from the balance sheet. For a services company there may be no inventory. That is fine, skip it.
- Calculate receivable days: trade receivables divided by revenue, multiplied by 365. This is roughly how many days it takes the company to get paid.
- Calculate inventory days: inventories divided by cost of goods sold, multiplied by 365. This is roughly how many days stock sits before it is sold. If the income statement does not show a single cost of goods sold line, add cost of materials consumed, purchases of stock-in-trade, and changes in inventories.
- Repeat steps 2 to 4 using the report from 3 years earlier.
- Put the 4 results in a row: receivable days then and now, inventory days then and now.
What you should see. For a stable, well-run company, both numbers move within a narrow band. Receivable days might be 42 then and 45 now. Inventory days 60 then and 58 now. Nothing to investigate.
What you are looking for is a large one-way move. Receivable days going from 45 to 95 means the company waits more than twice as long to be paid as it used to. Something changed: the customers, the terms, or the quality of the sales.
Then do the arithmetic that makes it concrete. Multiply the increase in days by revenue and divide by 365. That is roughly the extra money tied up in customers who have not paid. Compare it to the year's profit after tax. In companies that later got into trouble, that figure is frequently larger than a full year of profit.
Three real cases
1. Satyam Computer Services, 7 January 2009 (India) — the safest asset on the page was invented Satyam's balance sheet showed large cash and bank balances. In his letter to the board on 7 January 2009, chairman B. Ramalinga Raju admitted the accounts had been manipulated across several items, in the region of ₹7,000 crore, and that a large part of the reported cash did not exist. The auditor was PricewaterhouseCoopers. Even cash is a claim in a document until somebody independent confirms the bank balance. Raju and 9 others were convicted on 9 April 2015.
2. Hewlett-Packard and Autonomy, 20 November 2012 (United States and United Kingdom) — goodwill from an acquisition, written off a year later HP acquired the British software company Autonomy in 2011 for approximately $11.1 billion. Most of that price became goodwill and intangible assets on HP's balance sheet. On 20 November 2012 HP announced an impairment charge of about $8.8 billion related to Autonomy, attributing more than $5 billion of it to what it called serious accounting improprieties at Autonomy before the purchase. An asset worth billions on one balance sheet was worth a fraction of that on the next one, with no transaction in between.
3. Carillion plc, 2017 to 2018 (United Kingdom) — receivables the customer had not agreed to Carillion's construction contracts generated large amounts owed by customers for work the company said it had done, some of it not yet certified as complete by those customers. On 10 July 2017 it took an £845 million impairment charge, largely on construction contracts, and it entered compulsory liquidation on 15 January 2018 with about £29 million of cash. KPMG and Carillion had also maintained a £329 million goodwill valuation on one acquired business despite losses in it. Two asset lines held up a balance sheet that had already failed.
The question that resolves it
A novice looks at the asset side and asks: how much does this company have?
An expert looks at the same page and asks: how much of this will become cash, and how long will it take?
Cash is already cash. Receivables become cash in 45 days, or 95, and the notes tell you which. Inventory becomes cash after it is sold. Goodwill becomes cash never — it can only ever be reduced.
Sort the asset side by that question and the balance sheet stops being a list and becomes a description of a business.
What would make this wrong
If rising receivable days always signalled trouble, then every company that entered a new market with longer payment norms would be a warning. They are not.
Three honest limits.
Seasonality distorts the calculation. A company whose biggest quarter ends in March will show high receivables on 31 March simply because it just sold a lot. Comparing the same date across years fixes most of this, which is why the exercise above uses 31 March in both years.
Business model changes are legitimate. A company that moves from selling to distributors to selling directly to large corporate customers will see receivable days step up permanently, because large customers pay in 90 days. That is a one-time step, not a trend. If it steps up and then holds flat, believe it.
Goodwill is not evidence of anything by itself. Acquisitions can be excellent. A large goodwill balance in a company that has integrated its purchases well and grown their profits is not a problem. The question is whether the profits of the acquired business justify the price, and the segment note is where you check.
In India
Schedule III fixes the order and the wording, which makes Indian asset sections easy to compare across companies once you learn the layout.
Three Indian specifics are worth knowing.
The receivables ageing table is mandatory. Since the 2021 amendment to Schedule III, Indian companies must present trade receivables in ageing buckets: less than 6 months, 6 months to 1 year, 1 to 2 years, 2 to 3 years, and more than 3 years, split between undisputed and disputed. This is a genuinely powerful disclosure and it does not exist in the same prescribed form in American filings. Money owed for more than 2 years is usually money that will not arrive.
Capital work in progress also has an ageing table, showing how long projects have been under construction, and a separate disclosure for projects that are overdue or over budget. A company with large CWIP more than 3 years old is telling you something.
Title deeds. Under CARO, the auditor must state whether title deeds of immovable property are held in the company's name. Property recorded as an asset but registered in a promoter's name is a real problem, and India requires the auditor to say so.
In the United States
American balance sheets present current assets first, in liquidity order: cash and cash equivalents, short-term investments, accounts receivable, inventories, prepaid expenses. Then property and equipment, then goodwill and intangibles.
Four American specifics.
LIFO inventory. US GAAP permits last in, first out valuation, which is banned under Ind AS and IFRS. Companies using LIFO must disclose the "LIFO reserve", the difference between the LIFO value and what the inventory would be worth under first in, first out. Add the LIFO reserve back before comparing an American company's inventory to an Indian one's.
Allowance for credit losses. American companies show accounts receivable net of an allowance for amounts they expect not to collect, and the movement in that allowance is disclosed. A shrinking allowance while receivables grow is worth a second look.
Research and development is expensed. Under US GAAP, R&D spending goes straight to the income statement rather than becoming an asset, with a narrow exception for software developed after technological feasibility is established. So an American pharmaceutical or technology company carries almost no asset for work that is genuinely valuable.
Goodwill impairments are explained in MD&A, which means an American reader usually gets a written reason for a write-down.
Where they differ, and what that tells you
The deepest divergence is about upward movement.
Under Ind AS, an asset's carrying value can go up. Property can be revalued upward under Ind AS 16, and an impairment recorded in an earlier year can be reversed if the situation improves, under Ind AS 36, for assets other than goodwill. Under US GAAP neither is generally permitted.
What that tells you is how to read an increase. In an American report, if the carrying value of a fixed asset rises, the company spent money. In an Indian report, it may have spent money, or it may have changed its mind about value. Only the notes distinguish them.
The second divergence is practical. India prescribes ageing tables for receivables and for capital work in progress. The United States does not prescribe them in the same form, though the allowance for credit losses disclosure covers some of the same ground.
So the workflow differs. In India, the ageing tables do the work for you: go to the notes and read them. In the United States, compute receivable days yourself from the face of the statements, then read MD&A to see whether management explains the movement. India gives you better raw data. The United States gives you a better explanation.
Carry this
- Sort assets by how fast they turn into cash, not by size.
- Receivable days and inventory days, this year against 3 years ago. That is the whole test.
- Goodwill can only fall. A large goodwill balance never impaired is a loss waiting to be recorded.