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.

Difficulty: Moderately Easy

Instructions

Understand How to Read a Balance Sheet

1. 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.

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.

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.

4. 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.

5. 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.

6. 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.

7. 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.

8. 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.

9. 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.

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.

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