Hello friends. I hope my blog post today finds you well!

Last time, I wrote about the nature of balance sheet assets according to the technical meaning assigned by the Financial Accounting Standards Board (FASB). Repeating the definition, assets are “probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events” (FASB Concept 6). Today, I’ll relate the definition to my Scorecard approach of discounting the asset values provided on the balance sheet.

In my book “Choose Stocks Wisely,” I offered reasons for discounting the value of non-cash current assets in determining ample balance sheet liquidity and for discounting total non-cash assets in determining adequate balance sheet solvency. Yes, I want to buy a stock very cheaply (parts C and D of my Scorecard) but I definitely don’t want to buy a stock in a business lacking sufficient liquidity for day-to-day operations or lacking physical positive equity (parts A and B of my Scorecard). Remember, a cheap business that lacks quality equity (net assets) is cheap for a good reason.

If we hone in on the word “probable” in the FASB terminology for describing an asset, we can see the intuitive action of discounting asset values in making judgments about ample liquidity and adequate solvency. The word probable means “likely.” Thus, it doesn’t mean “certain.” While some assets may indeed be the result of a contractual relationship thereby providing a legal claim to certain future economic benefits, in most cases the future economic benefits to be derived are likely, but uncertain. Will inventory be sold at a profit like we expect or lack demand and be written off? Will services be demanded such that physical assets like machinery and equipment are sufficiently utilized to produce profit to the business?

You see, most assets are not guaranteed to generate a return but the FASB definition assumes that items denoted as “assets” are items intended for use as resources which are expected to generate profit for a business. Thus, assets are “probable” future economic benefits. But the word probable again implies uncertainty. Uncertainty is risk. To lessen risk in analysis toward buying stock, one should discount the amounts recorded for assets on the balance sheet when testing for liquidity and solvency. At least that’s my practice.

See you next time.