Claims to Assets

Question: Below is the liability section of the balance sheet reported by Johnson & Johnson and Subsidiaries as of December 28, 2008. Note that additional information about many of these liabilities is provided in the notes to the company’s financial statements.

Liability Section of Balance Sheet, Johnson & Johnson and Subsidiaries as of December 28, 2008

All numbers in millions.

Decision makers who analyze an organization such as Johnson & Johnson usually spend considerable time

studying the data available about liabilities, often focusing on current liabilities. Why is information describing

liabilities, especially the size and composition of current liabilities, considered so important when assessing the

financial position and economic health of a business?

Answer: Liabilities represent claims to assets. Debts must be paid as they come due or the entity risks damaging

its future ability to obtain credit or even the possibility of bankruptcy. To stay viable, organizations need to be

able to generate sufficient cash on an ongoing basis to meet all obligations. Virtually no other goal can be more

important, both to company officials and any external decision makers assessing an entity’s financial wellbeing

and potential for future success.

In general, the higher a liability total is in comparison to the reported amount of assets, the riskier the financial

position. The future is always cloudy for a company when the size of its debts begins to approach the total of

its assets. The amount reported as current liabilities is especially significant in this analysis because those debts

must be satisfied in the near future. Sufficient cash has to be available quickly, often within weeks or months.

Not surprisingly, analysts become concerned when current liabilities grow to be relatively high in comparison

with current assets because the organization might not be able to meet those obligations as they come due. In a

newspaper account of Advanced Cell Technology, the following warning was issued: “It reported $17 million in

current liabilities, but only $1 million in cash and other current assets, an indication it could be forced to file for bankruptcy protection”.