Asset Quality is a term used by bank analysts and others in evaluating the Balance Sheet of a potential lendee. It is an analysis of the quality of the important classes of assets that the bank will rely on as collateral for making a loan, and judging the credit quality of the business. It is a concept that every business person should be aware of also.
Usually the quality that banks are interested in are those associated with accounts receivables, inventory and fixed assets, but they can look at other assets listed on the Balance Sheet if they are meaningful.
Quality in this context means are they “good” assets, meaning are the receivables collectible and being collected on a timely basis, is the inventory good in the sense is it selling and how long is it taking to sell it, and in the context of fixed assets, what are these assets worth in liquidation (remember we are talking from the banker’s perspective).
Banks will discount (lower the value for purposes of lending) those assets that are of low quality. So, if your receivable aging (the report which shows who owes you, and how long the invoice has been outstanding) shows substantial balances over due, the banks will not give you full credit for them. Same with inventory, if an inventory turn report (a report which shows the inventory in hand in dollars and in units, and calculates
how soon in months the inventory will be sold based on unit sale history) shows that significant inventory items are selling slowly relative to industry norms, then the inventory is going to be discounted for purposes of lending.
Knowledge of this type of analysis is needed when going for a bank loan, and is important as you look at your own business, or analyzing businesses you are
(If there is any area in accounting or tax that you think needs to be addressed in this newsletter please e-mail Dick at Ginnatycpa@aol.com and if it is of general interest, he will address it in future articles)