How to Read a Balance Sheet
A balance sheet presents an overview of what a company is worth by weighing what it owns against what it owes. Investors looking to buy a business or to purchase a company's stock should read all of the entity's financial statements, paying close attention to its balance sheet.
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Instructions
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Understand How to Read a Balance Sheet
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Recognize the two sides of a balance sheet. Balance sheets are divided into assets, liabilities and equity. Equity may also be called shareholders equity or owners equity.
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2
Understand what a balance sheet does. Balance sheets reflect the sum of the assets minus the sum of the debts. If the sum of a company's assets is more than the sum of its debts, the remainder is considered to be equity.
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3
Know what constitutes an asset. Assets have positive monetary value. There are hard assets, such as cash and land. Assets with fluctuating value include buildings, equipment and goods. Intangibles, like a company's reputation, may also have monetary value.
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Notice the time frame for assets. Current assets are readily convertible into cash within 1 year. Non-current assets have a conversion time frame of more than 1 year.
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Realize that most assets other than cash lose value over the course of time. Loss of value is referred to as depreciation. Depreciation can generally be calculated by a standardized formula and is subtracted from the value of the asset on a separate line of the balance sheet.
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Know what constitutes a liability. Any financial obligation owed by a company is a liability. Salaries and benefits are liabilities, as are accounts payable, loans and interest.
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Notice the time frame for liabilities. Short term debt is due within the year. Long term debt has a due date more than a year away.
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Make sure you are reading a balance sheet audited by an outside source. Audited balance sheets have been researched and verified by a reputable accounting company. The accounting company will sign off on the veracity of the numbers represented.
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Read a balance sheet for more than just the numbers. Look to see how the numbers relate to one another. A large amount invested in inventory could signal that the company's products are not moving. A significant number of accounts receivable for more than a year could mean customers aren't able to pay their bills.
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Tips & Warnings
The term "statement of financial position" is another term for balance sheet.
The value of a company's good name is often considered an asset. If one company has bought another company and paid a premium for that business's reputation, the premium will be listed on the balance sheet as "goodwill." Like any other asset, the value of "goodwill" will depreciate over time.
