5 Tips For Reading A Balance Sheet

AAA

Reading The Balance Sheet

A balance sheet, also known as a "statement of financial position", reveals a company's assets, liabilities and owners' equity (net worth). The balance sheet, together with the income statement and cash flow statement, make up the cornerstone of any company's financial statements. If you are a shareholder of a company, it is important that you understand how the balance sheet is structured, how to analyze it and how to read it.

1. The Balance Sheet Equation

The main formula behind balance sheets is: Assets = Liabilities + Shareholders' Equity

This means that assets, or the means used to operate the company, are balanced by a company's financial obligations along with the equity investment brought into the company and its retained earnings. The total assets must equal the liabilities plus the equity of the company.


2. Know The Current Assets

Current assets have a life span of one year or less, meaning they can be converted easily into cash. Such assets classes include cash and cash equivalents, accounts receivable and inventory. Cash, the most fundamental of current assets, also includes non-restricted bank accounts and checks. Cash equivalents are very safe assets that can be readily converted into cash; U.S. Treasuries are one such example. Accounts receivables consist of the short-term obligations owed to the company by its clients. Companies often sell products or services to customers on credit; these obligations are held in the current assets account until they are paid off by the clients.

3. Know The Non-Current Assets

Non-current assets are assets that are not turned into cash easily, are expected to be turned into cash within a year and/or have a life-span of more than a year. They can refer to tangible assets such as machinery, computers, buildings and land. Non-current assets also can be intangible assets, such as goodwill, patents or copyright. While these assets are not physical in nature, they are often the resources that can make or break a company - the value of a brand name, for instance, should not be underestimated. Depreciation is calculated and deducted from most of these assets, which represents the economic cost of the asset over its useful life.

4. Learn The Different Liabilities

On the other side of the balance sheet are the liabilities. These are the financial obligations a company owes to outside parties. Like assets, they can be both current and long-term. Long-term liabilities are debts and other non-debt financial obligations, which are due after a period of at least one year from the date of the balance sheet. Current liabilities are the company's liabilities which will come due, or must be paid, within one year. This is includes both shorter term borrowings, such as accounts payables, along with the current portion of longer term borrowing, such as the latest interest payment on a 10-year loan.

5. Learn about Shareholders' Equity

Shareholders' equity is the initial amount of money invested into a business. If, at the end of the fiscal year, a company decides to reinvest its net earnings into the company (after taxes), these retained earnings will be transferred from the income statement onto the balance sheet into the shareholder's equity account. This account represents a company's total net worth. In order for the balance sheet to balance, total assets on one side have to equal total liabilities plus shareholders' equity on the other.

6. Analyze With Ratios

Financial ratio analysis uses formulas to gain insight into the company and its operations. For the balance sheet, using financial ratios (like the debt-to-equity ratio) can show you a better idea of the company's financial condition along with its operational efficiency. It is important to note that some ratios will need information from more than one financial statement, such as from the balance sheet and the income statement.
  1. No results found.
Related Articles
  1. Investing

    Reading The Balance Sheet

    Learn about the components of the statement of financial position and how they relate to each other.
  2. Investing

    Breaking Down The Balance Sheet

    Knowing what the company's financial statements mean will help you to analyze your investments.
  3. Investing

    Comparing the P&L Statement and the Balance Sheet

    Basically, the balance sheet shows how much a company is worth, while the P&L statement reveals if a company is profitable or not.
  4. Investing

    5 Tips For Reading A Balance Sheet

    If you know how to read it, the balance sheet provides valuable information on a potential investment.
  5. Investing

    12 Things You Need To Know About Financial Statements

    Discover how to keep score of companies to increase your chances of choosing a winner.
  6. Investing

    What are Financial Statements?

    Financial statements are a picture of a company’s financial health for a given period of time at a given point in time. The statements provide a collection of data about a company’s financial ...
  7. Investing

    An Introduction To The Balance Sheet

    The balance sheet is a basic accounting tool used by individuals, business owners and even large corporations to track net worth. Discover its main components and how they work together.
  8. Investing

    Cash Flow From Operating Activities

    Cash flow from operating activities is a section of the Statement of Cash Flows that is included in a company’s financial statements after the balance sheet and income statements.
  9. Investing

    What Is A Cash Flow Statement?

    Learn how the CFS relates to the balance sheet and income statement as a part of a company's financial reports.
Hot Definitions
  1. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  2. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  3. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  4. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
  5. Yuppie

    Yuppie is a slang term denoting the market segment of young urban professionals. A yuppie is often characterized by youth, ...
  6. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
Trading Center