Understanding Balance Sheets
The balance sheet is one of the most important sources of information about a company. It's essentially a snapshot of what the company owns and what it owes at a given moment in time. Balance sheets are usually published at the end of each quarter for publicly traded companies, but can be calculated at any time with the proper information. Though no one format accommodates all business models, the general rule for constructing a balance sheet is that assets must equal (or balance) liabilities plus owners' equity.
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Instructions
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Assess the assets. The things a company uses to conduct its business are called assets. These include current assets (liquid investments, inventory and accounts receivable) and non-current assets (relatively illiquid assets such as buildings, machinery, and intellectual property).
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Learn the Liabilities. The obligations of a company, including debt, interest, and accounts payable, are its liabilities. Though the payments are yet to be made, this is essentially money that's already spent.
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Owners' (Shareholders') Equity. Money invested into a company exists as equity until it is spent. Profits not distributed as dividends return to the balance sheet as equity. If the company is publicly traded, the owners are the shareholders. The owners' equity is the company's net worth, the amount that could likely be obtained if the business were to liquidate its assets and pay off its liabilities. For the balance sheet to balance, assets must equal liabilities plus owners' equity.
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Analyze with ratios. Balance sheets can tell a lot more about a company than the information on the surface. Analysts use several key metrics, usually ratios, to determine the underlying financial health of a company. Ratios can assess a company's liquidity, operational performance, profitability, and investment value.
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Tips & Warnings
Information in a balance sheet can be useful in understanding how a company conducts its business and how it finances operations, business model considerations that can effect investment decisions.
Use balance sheet in conjunction with cash flow and income statements to get a more complete picture of a company's finances.
There are several acceptable formats for presenting balance sheets, so it may take some time to interpret unfamiliar formats.
A change in the way a company reports its balance sheet might be a red flag for accounting shenanigans.
Assets must equal liabilities plus equity or someone's stealing money!
Resources
- Photo Credit Exxon Mobil
