It is a common asset that is widely found in the balance sheets of the businesses, and it includes chairs, machinery, computers, table, desks etc.
What is an asset? An asset is an item that is invested in with the intention of gaining future benefits from it. An asset can be any item that holds monetary value. Any individual or organisation can own an asset that promises them a future financial benefit or a stream of income. Assets can be tangible or intangible. For instance, land is an asset as it can be loaned out in exchange for rent. Similarly, a patent, which is intangible, can also be considered as an asset as it provides monetary value to the owner of the patent. How is an item categorised as an asset? All assets hold three fundamental properties that set them apart from any other type of holdings or investments by firms and individuals. These include: Ownership: Assets involve the concept of ownership. The owner of the asset must pay for it and should benefit from the future income stream. This ownership is what allows the owner to gain monetary benefits from the asset. Economic Value: Assets are items that hold some form of monetary value and are not entirely worthless. This is important because an item can only be sold, loaned, or exchanged in the market when it holds some value. Future Benefit: This quality is what sets an asset apart from any other item purchased by an individual or a company. For any resource or object to be categorised as an asset for the owner, there must be a stream of income that it promises in the future. For instance, an individual might consider a family heirloom as an asset. However, the economic value associated with it might not be much. So, if the heirloom were to be exchanged in the market, it would not be of any benefit to the owner. Hence, it is not an asset. What are the types of assets? Assets can be divided into various types based on different categorisations. Broadly, assets can be divided into the following types: Personal Assets: These are the assets owned by individuals or households, and they generate some value for the owner. These may include property, jewellery, physical cash and cash equivalents, savings accounts, and investments such as bonds, pensions, mutual funds, etc. Business Assets: These assets are held by companies and are held with the intention of generating profits. These assets are added in the balance sheet of a company while the liabilities are subtracted from them. Assets may serve different purposes in a business. Individual businesses may use physical assets like machinery and equipment to produce output. While other intangible assets can be used for profit generation in the future, simply by selling them, for instance, a company might sell the intellectual property rights of one of their products to gain profits from them. Based on how easily the assets can be converted into cash, they can be further categorised into different types: Current Assets: Assets that can be easily converted into liquid money are current assets. The time frame for this conversion is typically under a year. These may include cash and cash equivalents, account receivables, inventory, marketable securities, short-term deposits. These assets help finance the day to day operations of a business and thus, are easily convertible into liquid money. Fixed or Non-Current Assets: These assets can not be easily converted into cash. They are typically used in the production process and can last more than a year. They are recorded in the balance sheet under the headings “property, plant and equipment”. They are long term assets and are generally tangible assets. Some examples of fixed assets include building, vehicles, machinery, office furniture. Assets can be categorised based on their usage into Operating and Non-Operating Assets. Operating assets are the assets used daily, while Non-Operating Assets are not used as frequently but are still crucial for a business. Operating assets would include cash, machinery, equipment patents, etc. In comparison, non-operating assets would consist of short-term investments or land or real estate that might come in usage later and do not have an immediate requirement. Assets may also be categorised based on their physical existence into tangible and non-tangible assets. Tangible assets are physical assets like land, building machinery, inventory, while intangible assets may include various other aspects of a business that do not have a physical existence like goodwill, copyrights, trademarks, licenses and permits, intellectual property, etc. How are assets valued? The value of an asset held by an individual or an organisation at a time may not be equal to what it was at the time when it was bought. The value of an asset is affected by factors like depreciation and fair value. In case of a physical asset, depreciation is the wear and tear that an asset undergoes with the course of time. However, depreciation can be generalised as the process of spreading the cost of an asset over time. It decreases the value of an asset or an item over time. Fair value refers to the market value of an asset at a point of time. If an asset of a company was to be sold in the market five years after it was bought, then the fair value of the asset refers to the amount that it would sell for at that point. This value is derived through the process of fair market value analysis, where prices of other assets are compared to the asset in question. Some professionals are skilled at calculating fair value.
Liquidation value is defined as the total value of a company's physical assets if the assets were sold or go out of business. This value is the value of company’s fixtures, inventory, real estate, and equipment. Intangible assets are not included in the liquidation value of the company.
What are retained earnings? Retained earnings is the amount of net profits left with the business after paying dividends. It is reported on the balance sheet and is the cumulative net income minus the cumulative dividends since the inception of the firm. In the balance sheet, the retained earnings of the enterprise are reported within the shareholder’s equity. However, the number sitting on the balance sheet as retained earnings does not necessarily mean hard cash, but the funds used to pay liabilities or acquiring assets. Income statement accounts for revenues, gains, expenses and losses of the firm, therefore net income is derived when revenue and gains exceed expenses and losses. Now the net income of the firm is transferred to retained earnings. When the firm records net income, it increases the retained earnings. However, net loss reduces the retained earnings. Net loss occurs when the firms' expenses and losses exceed revenue and gains in an accounting period. Dividends are also paid out of the retained earnings. When an enterprise declares a dividend, it reduces the retained earnings on the balance sheet. Depending on the stage of the business, the retained earnings can have a credit balance or debit balance. A credit balance means positive retained earnings, while debit balance means negative retained earnings. A positive balance of the retained earnings shows accumulated profits of the firm, whereas a negative balance of the retained earnings means accumulated losses. A firm that was established recently, such as start-ups, could incur losses during the initial years, leading to debit balance in the retained earnings. Retained earnings formula: What are the uses of retained earnings? Dividends: Companies with limited investing and working capital needs often pay dividends to the shareholders. When the growth opportunities for the firm are exhausted and is growing consistently with the industry, the firm can pay dividends since capital expenditure needs are limited. Dividends remain one of the main return drivers in a portfolio over the long term. Even if the business has suffered net loss, it can pay dividends because of positive cash balance and reserves in retained earnings. Working capital: Working capital management is crucial in a business and also depicts the short term needs of the business. Working capital is the liquidity of the business to manage its day-to-day operations. Working capital requirements of a firm can be fulfilled by equity or debt. Funding working capital needs through retained earnings is an equity type of financing. In addition, a firm’s current assets like cash, inventory and receivables, are used to fund working capital needs. Fixed investments: Fixed investments primarily means investments in large scale assets to improve production. Retained earnings are also used to fund capital expenditure plans of the firm. Capital expenditure can include purchasing assets like furniture, equipment, plant etc. It can also include funds used to improve the quality and utility of the assets. Other needs: A firm also has other needs that can be fulfilled through retained earnings. Other applications of retained earnings can include shares buyback, repayment of the loan, R&D investments, expansion etc. Why companies prefer to retain earnings instead of disbursing dividends? A company would retain earnings primarily because of the above uses. However, when the company does not have retained earnings, the funding source for the above uses will likely be either an equity raise or debt. Both the funding sources also come at a cost. In equity, the shareholders of the company would face dilution of interest or ownership. In debt, the expenses increase because the company has to bear the interest costs and also repay the principal at maturity. In comparison, the equity funding route is mostly preferred by the companies, depending on the scale of requirement. Large funding requirements are likely to be funded with debt capital given the risks of large dilution. Companies may also elect to refrain from paying dividends, specifically when the management believes that better shareholder value can be created by using retained earnings to fulfil needs of the business. Mostly growing firms are likely to refrain from paying dividends or pay a lower amount of dividends primarily because growth and investment opportunities for growing companies are relatively higher than matured companies or blue-chip companies. Revenue vs Retained Earnings Revenue is recorded on the income statement and is referred to as the top line of the company. It is the amount of total income earned by the company by selling its goods and services. All the expenses incurred by the company during the financial period are deducted from revenue to arrive at net income. Retained earnings of a company are the funds that were left with the firm after paying dividends out of the net income. A company utilise retained earnings for the future benefits for the business and to meet the current need of the business. Warren Buffet on Retained Earnings Warren Buffet in his 2019 Annual Letter acknowledged the importance of retained earnings. He noted that great American businessmen like Carnegie, Ford and Rockefeller had retained a large portion of earnings to fund future growth of the business. He and Berkshire’s second-in-command, Charlie Munger, have extensively focused on retained earnings. The firm’s priority is to reinvest in operational assets, which are productive. Mr Buffet reckoned that Berkshire’s portfolio companies, where Berkshire hold over 50% interest, have retained earnings but that those retained earnings do not factor in Berkshire reported earnings.
What are Consumer Packaged Goods? Consumer packaged goods (CPG) are the most common household products. Also known as fast-moving consumer goods (FMCG), these include non-durable items like cosmetics, toiletries, beverages, packaged foods etc. Durable goods are products that are used for a long time, such as appliances, automobiles, furniture. FMCG industry is a crucial industry in an economy and manufactures essential and daily-use items for the people of a country. The distinctive feature of these products is they need to be immediate consumed. Low priced consumer electronics like mobile phone, earphones, data cables, portable speakers are also considered under the fast-moving consumer goods market. FMCG also includes highly perishable items like meat, vegetables, fruits, meat products, dairy products, grain mill products, spirits, wines, soft drinks, mineral products, tobacco products, bakery products, dairy products, sugar, etc. The size of the consumer-packaged goods industry also depends on the population of the country, for example, a country like China, with the largest population will certainly have a broader market than Australia. Fast-moving consumer goods have numerous retail counters, they are sold in supermarkets, small shops, as well as online. Over the years, the growing penetration of smartphones has perhaps ignited the demand from consumers that want to shop FMCG through mobile phone applications. What are the characteristics of a CPG business? Image Source: © Kalkine Group Essential products and stability During the course of a day, a person utilises items from FMCG industry on multiples occasions starting from brushing teeth, eating breakfast to cooking lunch. As the goods are essential, the businesses in the sector largely remain unscathed from cyclical upsides and downsides. Consumer behaviour may change towards lower-priced substitutes during hardships or cyclical downside, but consumption continues. As a result, the industry largely remains stable, and growth is mainly dependent on changes in the underlying demographics like population. Large wallet share As consumer products largely include items needed to survive, the spending on consumer products has a lion wallet share. For an average consumer household, the month starts with budgeting and spending on essential items. Low-priced product and quick decision-making The application of consumer products is widespread during the course of a day; therefore, they are available in all shapes and sizes. For instance, when someone is on a trip for a week, the market has to offer a compact size of toothpaste. In today’s world, for any high end, famous, and essential products, there are low-priced variants available. The consumer does not spend significant time while shopping fast-moving consumer goods, although a buyer may evaluate prospective purchase with various alternatives before buying a car etc. Low Capital Intensive industry The products to be manufactured belonging to FMCG sector do not require heavy financial investment in machinery, plant etc. Since the investment in this sector is not that high, it also avoids supply issues. High launching costs Even though the initial capital investment is not that high, but due to increased competition, launching a new consumer product requires a large upfront investment. An entrepreneur has to spend time and money in product development, market research, testing and launch. Awareness is the key point here. People need to be aware and educated about the new product to be launched. Money spent while launching a CPG is basically for registering the product in the consumers mind. Even though consumers may not buy the product, they should at least be aware of the launch, which will instigate a response when they come across the product anywhere. Moreover, an entrepreneur is also bided to spend for the advertisement and marketing of the product. What contributes to the success of a CPG business? Brand Equity A CPG company operates across a range of product, and each product has a different name, logo and packaging. Brand equity is something which allows the consumer to identify the product quickly among many similar products. It essentially refers to the intangible assets of a firm, which are in the form of brand names, logos etc. The consumers tend to develop brand loyalty over time after using and gradually hesitate to try a substitute product. Developing brand loyalty among customers is only possible when the product has a strong logo, catchy name, moreover brand equity. Although FMCG products are largely identical with similar utility, a brand provides a reason for a customer to purchase it over others. It is the power, reach and acceptance of a brand across various products that help a consumer product company to generate strong free cash flows. With strong free cash flows, the company has the room to reinvest in brand, consumer and marketing to maintain a market position or even grow. Brand and its utility to the consumer also helps the firm to achieve the pricing power – a competitive advantage. When consumers are loyal to a brand, they are likely to buy the same irrespective of the increase in price. Supply chains A strong and continuously improving distribution network is a precursor for achieving superiority for a consumer product company. It is the responsibility of a company and the effectiveness of its supply chains to ensure that consumers don’t pick substitute products just because the retailer ran out of the produce. A firm always tries to ensure that products are available to consumers. It requires wider penetration of goods. Building robust supply chains and distribution network requires maintaining relationships with retailers, dealers, wholesalers etc. When a new product enters the market, the demand for the product is relatively lower, thus distributors are less inclined to allocate resources. Sometimes established players enter into exclusive contracts with distributors to the fend-off competition. Consumer behaviour Consumer behaviour continues to evolve continuously constantly with changes in society, networking effects, demographic changes, taste and preference etc. A consumer-packaged goods firm has to ensure that products are evolved with changes in consumer preferences. Companies undertake research and continuously monitor changes in consumer behaviour. For maintaining market share, it becomes imperative for companies to incorporate enhancements in products according to changing behaviour.