If you’re trying to gauge a company’s complete financial situation, then you’ll need to take a look at the company’s balance sheet. The balance sheet is a record of the company’s assets and liabilities, with the “leftover” amount being the shareholder’s equity, or what the value of the company is. Reading a balance sheet does not have to be time-consuming, especially if you know what you are looking for. Here are some tips for reading a balance sheet.
First, in reading a balance sheet, you’ll want to look at the company’s assets. Current assets are those which are used by the company on a day-to-day basis or could be liquidated to cash easily if necessary. Current assets include cash, accounts receivable, inventories, deferred income taxes, and prepaid expenses. When examining a company’s current assets, you will want to consider how much company a cash has on-hand (if a company does not have a lot of cash, then this could mean trouble if the company runs into issues). You will also want to look at the amount of inventory a company is holding on the balance sheet. If the amount of inventory is increasing considerably on an annual basis, then this could mean that the company is inaccurately projecting sales growth and that the demand for its products is decreasing.
The company’s non-current assets, such as Property, Plant, and Equipment, Goodwill (investments in a company’s brand name), Intangible Assets and other assets are listed next on the balance sheet. When looking at the non-current assets, you should look for large swings in these values from one year to the next in order to understand how much a company is investing in (or not investing in) its future. If a company has completed large investments in these assets, but is not seeing increased returns in income, then you should look at whether the company is investing in the right things. You’ll also want to take a look at the effect that this has on the company’s cash and debt situations to determine whether the company is healthy from a cash flow standpoint.
The balance sheet also breaks down liabilities into current and non-current classifications. Current liabilities include accounts payable and short-term debt, both of which are expected to be paid shortly. The company’s long-term debt and other liabilities are listed next. Again, you will want to look closely at the company’s long-term debt in relation to the cash it has and the earnings that it is generating to ensure that the company is in a position to pay down this debt.
Finally, when reading a balance sheet, you will consider the shareholder’s equity. This can be confusing, but the most important parts to look at are retained earnings (the amount of the company’s profits that are not paid out as dividends but are instead used by the company to invest itself or pay debt) and additional paid-in capital (the premium that the company receives from investors). These values in of themselves are not as important as understanding that assets minus liabilities are equal to the shareholder’s equity, bringing investor’s closer to finding the overall value of the stock.