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Imperial1964 (97.78)

Current assets < current liabilities important?

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June 10, 2007 – Comments (4)

Having current liabilities larger than current assets will require a company to raise capital to pay their bills.  A couple of companies I am researching in-depth (UNP and UNH, specifically) have current liabilities larger than their current assets for the last 3 years.  But they both have growing earnings and, for the most part, growing cash flows. 

In personal finance, it is very important that my current liabilities not exceed my current assets.  But as a newbie hoping to learn from the wisdom of the CAPS community, I ask you how important you believe this relationship is, especially as related to companies that are steadily growing earnings and cash flow?

4 Comments – Post Your Own

#1) On June 10, 2007 at 9:02 PM, StockSpreadsheet (71.66) wrote:

I think it somewhat depends on why their current liabilities exceed their current assets.  After all, when I bought my condo, I would say my current assets were less than my current libilities, (the debt on my house was larger than my bank accounts and my investments).  But in the long term, I pay off the debt and my assets grow. 

As relates to a company, if they have a large current debt because they just bought something or are in the process of buying something, (new plants, new equipment, new stores, etc.), then it might not be too bad.  Also, it seems some companies regularly have more libilities than assets, (financial companies, airlines, etc.), and do just fine, (though I don't think this is true for most airlines).   So I don't think that it is always bad, depending on what they are doing with the money.  If it was used to buy back stock or give a huge bonus to the CEO, that would be bad.  Investing in new R&D or new stores might be good.  I would pay close attention to the debt-to-equity ratio to see if it is rising or falling.  Rising debt-to-equity with rising revenues would concern me and I would want to know if maybe they are juicing their revenues with the debt, (a la Enron).  Falling debt-to-equity with rising revenues AND earnings would make me feel better, (rising revenues being very important to this consideration), as I think it would lead me to believe that they are using their debt wisely to grow the company and their earnings.  

Just my two cents.  But then, what do I know.  Your rating is much higher than mine, so take this for what you think it is worth.

Craig 

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#2) On June 27, 2007 at 12:43 AM, PreCFAJNM (20.90) wrote:

Please don't judge me based on my score. 

The following is all "in my opinion"

There are 3 kinds of people in this world

1. Those who will never pay off a house

2. Those who will pay off a house as fast as possible

3. Those who will never pay off a house

I didn't make a mistake, 1 and 3 are almost the same.  Except, I listed these people in order from dumbest to smartest.

The first person is dumb, at both saving, managing debt, cash whatever have you. 

The second is a saver, and doesn't want to pay somebody else the mortgage payment - smart.

The third and smartest person will realize having your entire house paid for, and not collecting a return on that money (other than appreciation of the property) is wasteful.  This person will keep a comfortable level of equity in their house, before buying another one, and renting out rooms - for example, thus earning a higher return on equity.

My point, in the end, that's what it all boils down to, return-on-equity, everything else is just numbers to make it work. 

And yah, obviously watch out for Enron...but i wasn't old enough drive yet when that went down.

Good discussion! 

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#3) On June 27, 2007 at 12:22 PM, Imperial1964 (97.78) wrote:

I won't judge you by your poor score if you won't judge me by high score!  I was just weeding out some losing picks last night to find that if you took out my bets on energy my score wouldn't be very good.  But CAPS is just my testing ground.

My mock-portfolio on AOL is beating the S&P's 8% gain YTD by another 3%.  Hope I can do that with real money!!!

Anyway, I'm person #2, primarily for the following reason: risk.

To me, leverage = risk.  I'm sure you can often get a higher return on equity with higher leverage, but it isn't necessarily worth the risk.  Instead, I bought a very modest home.  Lower taxes, lower utilities, no mortgage.  So, no matter what happens to my inflow of cash, I'm in little danger of losing my home.  And since I have put up no more equity than person #3, I am free to put just as much cash in the stock market, without having the monthly mortgage payment.

This is attitude of buying cheap and seeking to maximize returns is also my investing strategy, getting back to the meaning of the homeowner analogy.

But my original question isn't really about total assets to total liabilities.  It is about current assets and current liabilities.  If I have more bills due this month (current liabilities) than cash and income this month (current assets), that's a bad thing.  How do companies continue in this manner for years?  And should I reconsider investing in such a company? 

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#4) On July 09, 2007 at 3:30 PM, Imperial1964 (97.78) wrote:

A week ago I talked this subject over with a friend of mine who is studying to be an accountant.  He said that if current liabilities is larger than current assets, the difference will have to either come in the form of new debt, or come out of the revenue.  But if the company has enough net revenue to cover it comfortably, then there is no problem.

Sounds good to me, though I am no accountant.

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