How to Analyze a Balance Sheet
The balance sheet provides a snapshot of what a company owns (assets) and what it owes (liabilities) at a specific point in time.
It follows the fundamental accounting equation:
Assets = Liabilities + Shareholders' Equity
Assets
Assets are resources owned by the company that have economic value. They are listed in order of liquidity.
- Current Assets: Cash, accounts receivable, inventory. (Can be converted to cash within a year).
- Non-Current Assets: Property, plant, equipment (PP&E), intangible assets like patents and goodwill.
Liabilities
Liabilities are obligations the company owes to outside parties.
- Current Liabilities: Accounts payable, short-term debt, accrued liabilities. (Due within a year).
- Long-Term Liabilities: Long-term debt, deferred tax liabilities, pension obligations.
Shareholders' Equity
Also known as net assets or book value. It represents the residual interest in the assets of the entity after deducting liabilities. It includes:
- Common Stock: Capital invested by shareholders.
- Retained Earnings: Cumulative net income retained by the company rather than distributed as dividends.
Key Ratios from Balance Sheet
- Current Ratio: Current Assets / Current Liabilities. (Measures short-term liquidity).
- Debt-to-Equity Ratio: Total Liabilities / Shareholders' Equity. (Measures financial leverage).
- Return on Equity (ROE): Net Income / Shareholders' Equity. (Measures profitability relative to shareholder investment).