Dissecting balance sheets and getting to the root of financial statements are not really the stuff that gets me all energised. Assets, liabilities, inventories, cash and bank balances are insipid compared to the engineers' arsenal of double derivatives (no pun intended) and triple integrals.
But as uninteresting as brushing one's teeth, or eating 'karela' (bitter gourd) may be, they are a necessity for good hygiene and health. Likewise, being able to read between the lines of balance sheets, Profit & Loss and Cash Flow statements is a necessity for better health of one's stock portfolio.
Today's discussion was triggered off by reader Rishi's query last week. Why is it that a stalwart company like HUL is showing negative Net Current Assets on its balance sheet year in and year out? I was taken aback. How could that be possible? A market bellwether and leading FMCG multinational has more liabilities than its assets? After generating huge cash flows and paying continuous dividends?
Unfortunately, I could not locate last year's Annual Report. It came more than a year back and after a quick review to check every thing was in order, I didn't need to refer back to it any more. So I checked up at the Rediff money site, and guess what? Five straight years of negative Net Current Assets.
Now, any semi-intelligent high school graduate will be able to tell you that Net Current Assets (i.e. Current Assets - Current Liabilities) should be zero at worst, never negative. In other words, any company should own enough readily accessible assets to cover what it owes to others in the near term (within the financial year).
Ideally, the ratio of Current Assets to Current Liabilities should be 2 or more. But 1.5 is an acceptable number. That would indicate that a company has more than enough money to pay off the loans due and its creditors.
Unable to locate the HUL Annual Report to check the details, I checked up ITC's report instead. Sure enough, the Current Assets to Current Liabilities ratio was a respectable 1.58. Cummins India's? 1.67. Glaxo Pharma's? 1.91.
Now I was getting a bit jittery. Without the Annual Report, how will I respond to Rishi? Suddenly, I remembered my friend Nasir, who is an experienced Chartered Accountant in a multinational company. He had kindly offered to help me out with accounting intricacies if I faced problems.
Nasir's response was prompt and detailed. HUL's modus operandi is unique in corporate India. At the beginning of the year, they collect advance payments from their distributors. No distributor has the temerity to say 'No'.
These substantial advance payments are reflected in their books as a "Current Liability", though the company has no intention of paying back the money. What they do instead, is to supply their various products to the distributors throughout the year against the advance payments.
Consequently, the 'Debtors' figure under the head of "Current Assets" is negligible or nil. And the company is always flush with cash. Funny thing is, I knew about all this because an acquaintance used to be a HUL distributor.
Why do the HUL distributors effectively fund the company's operations? This is what happens when a company becomes so large and so popular, that it almost becomes a monopoly and can negotiate advantageous business terms with its suppliers and distributors.
Does all this smack of sharp business practices? Not at all. The company has worked hard over the years to create good products and establish strong brands. They spend hundreds of Crores in advertising to maintain their leadership position in the FMCG segment.
Why shouldn't they cut the best deal possible for themselves, and their shareholders? Microsoft does it. I would do it if I was able to garner that kind of market domination.
After all, a company exists to make profits. Not to win popularity contests. If it can do so without violating the law of the land, more power to them. Whether its Current Assets are more or less than its Current Liabilities.
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