How to analyze a balance sheet (without a finance background)
You don't need a finance degree to read a balance sheet
A balance sheet is 1 part of 3 company financial statements, and perhaps the most important one.
It shows you a company’s:
Assets
Liabilities
Net worth
Here’s the math behind a balance sheet
Assets = liabilities + shareholder’s equity
Assets are items that are of value that a company holds. These are used to operate the business.
Liabilities and shareholder’s equity are used to fund the assets that facilitate business operations.
The balance sheet can be broken down into 3 sections:
1. Assets
a. Short term assets
These are your most liquid assets, which can be easily converted to cash (<1 year).
Examples include:
Cash and cash equivalents
Accounts receivable
b. Long term assets
These are assets that can’t be converted to cash at short notice (>1 year).
Patents
Goodwill
Plant and Equipment
Real estate assets
2. Liabilities
a. Short term liabilities
These are payments that are due within 1 year.
Examples:
Taxes payable
Short term loans
Accounts payable
Accrued expenses
Interest payments on long term debt
b. Long term liabilities
These are debts and financial obligations owed in 1 year or more.
Examples:
Deferred taxes
Corporate bonds
Lease payments
Equipment loans
Deferred compensation
Long term liabilities can be paid off using a variety of business activities.
3. Shareholder’s Equity
This is the total dollar amount that shareholders would receive if a company is liquidated.
Treasury stock
Common stock
Preferred stock
Retained earnings — a company’s net worth
Some important ratios to consider, that are found on a balance sheet:
Debt to equity = Total liabilities / Total equity
Aim for below 2.
Quick ratio = Current assets — inventory — prepaid expenses / current liabilities
Aim for more than 1.
Current ratio = Current assets / current liabilities
Aim for more than 1.
A balance sheet gives us an overview of how strong a company is financially. It shows us what a company owns, and what it owes.
This is a key part of analyzing a company’s financials before deciding to invest in it.