Page 59 - Finance for Non-Financial Managers

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Finance for Non-Financial Managers
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sources of liquidity or cash flow. They are, well, “fixed” in place,
until they are no longer useful to the business. At that point,
they are either sold or discarded and then replaced.
Fixed assets may not move around much, but during their
period of use, their value declines substantially, often to zero by
the end of their service. The sole exception to this is land, which
does not decline in value, but is more likely to increase in value
over time. In order to recognize that reduction in value, a com-
pany will depreciate, or systematically write down, the cost of
each fixed asset (except land, which almost never declines in
value) over the period of time that it will be used in the business.
That reduction in value is charged to expense when recog-
nized, under “Depreciation Expense” in the income statement
(see Chapter 4). On the balance sheet, the total amount written
off to expense since a fixed asset was purchased is shown
under “Accumulated Depreciation.” This account is shown
immediately after the original cost of fixed assets as a deduction
from original cost, so that the net value of fixed assets is readily
apparent to anyone who reads the statement.

Avoid Getting Caught with Your Assets Down!
In evaluating a company, look carefully at the relationship
between fixed assets and accumulated depreciation shown
on the balance sheet. If the accumulated depreciation is a large per-
centage of total fixed assets and very little remains to be written off, it
may be a sign that the company is facing potentially heavy expendi-
tures in the near future to replace aging equipment that may no longer
be able to do its job. In an industry influenced by technology, such as
automobile manufacturing, this may be even more of a concern.
Alternatively, keeping old equipment in place may result in higher
maintenance and repair costs. Either way, it could be a clue to future
drains on cash flow or the need to borrow money for replacement
purchases.
The smart strategy: keep up maintenance programs on equipment
with long service lives, to avoid shortening useful lives unnecessarily.
When equipment must be replaced, use return on investment (ROI)
calculations to find the best way to finance the replacement.