Here Are Your Company Balance Sheet Crib Notes

For investors, a company balance sheet can provide important information when considering investing in a company. It provides a snapshot of the company’s assets, liabilities, and shareholders’ equity.

Learning how to read a balance sheet is a core skill to learn because it can help you determine whether a company is moving in the right direction. Understanding a company’s debt load and its borrowing costs are important to consider before buying shares of a business. That’s especially true in today’s higher interest rate environment, where the cost of debt is high. A high amount of debt can eat up profits. Some debts however might be desirable. For instance, businesses investing lots of capital in new technology or exploration projects might be exceptions to the rule.

What is a balance sheet?

A balance sheet is a financial statement that lists a company’s assets and liabilities. Understanding this statement is a must for investors interested in trading. The way a company structures its balance sheet and the amount of interest it pays on its debt can significantly affect a business’s cash flow, which ultimately affects the price of the stock, now and in the future. Company balance sheets, which are updated quarterly and annually, can be intimidating at first glance, but the premise behind them isn’t much different from how you might track your own assets and expenses at home.

Here’s a look at what the different sections of the balance sheet represent and how to interpret the information you find there.

1. Liquid assets

Current assets include cash and other assets that can be converted to cash within a year, such as inventory, investments and accounts receivables. This part of the balance sheet can help you determine if the business can pay its bills without raising funds, sometimes referred to as its liquidity.

Pro tip: The current ratio, which divides the company’s current assets by its current liabilities, is one way to measure liquidity – the higher the number, the better.

2. Assets that power the business

Businesses make money by selling products and services, but they also need to retain some assets to operate. Non-current assets are long-term investments in things like property, patents, trademarks and equipment. These are core to the business and have value, but they are harder to sell.

3. Growing in the right direction

Is the company growing its assets year over year? If you see a decline here, it might be worth investigating further to find out why.

4. Short-term liabilities

It costs money to make money. An increase in short-term liabilities, like accounts payable, income tax, financing and payroll, could mean the company is facing more pressure to find cash to cover its obligations.

5. Long-term obligations

These are liabilities that are due a year or more out. These may include loans, bond repayments, leases and pension provisions. A sudden increase in this part of the balance sheet can be a sign a company has increased its borrowing obligations, which can sometimes increase the risk of default.

6. Company’s net worth

Determining the value of a business is similar to how you calculate your own net worth by subtracting liabilities from your assets. It consists of money that shareholders have contributed to the business (usually in the form of shares) and earnings that the company has generated over time that have been retained in the business.