What is a business worth? To get the answer, you’ll need to look at his track record. A balance sheet is a statement showing the financial position of an entity by reporting the assets, liabilities and equity on a specific date (usually at the end of an accounting period). It shows what a company owns and owes, as well as shareholder ownership.
A balance sheet is one of the main financial statements that every public company must publish on a regular basis. This is something every investor should know and understand, as it provides important context for the financial health and value of a business. Here’s everything you need to know about a balance sheet.
What is recorded on a balance sheet?
The balance sheets of public enterprises have three final sections: assets, liabilities and equity. The “balance” comes from examining what is held versus what is owed:
Assets = Liabilities + Equity
- Assets are what the business owns and include both current and fixed assets.
- Liabilities are debts owed by the business, including loans.
- Equity represents the amount of equity offered by shareholders.
In each of these sections is a more complete breakdown which represents the total sum of each column of the balance sheet. For example, under assets, you will find cash and cash equivalents, accounts receivable, inventory, fixed assets, intangible assets, and more. Likewise, under liabilities you can find loans, accounts payable, deferred tax liabilities and more. Finally, the equity section would include items for reinvested earnings and common stock.
Reviews need a well-organized attribution to ensure that readers can identify the major contributors to each section. Specific items for each type of asset, liability and equity add clarity to the report as a whole.
How it works?
The balance sheet tells the story of how a business works: it acquires assets by borrowing money or issuing shares. If the balance sheet of a company is much more nuanced, the fundamental activity remains the same.
The balance sheet must live up to its name by remaining balanced. To do this, companies rely on double-entry accounting practices. Each balance sheet entry needs an offsetting entry elsewhere. Here are some examples :
- When a business obtains a loan, liabilities and cash flow increase by the amount of the loan.
- As the business repays this loan, it reduces cash assets and liabilities in the same way.
- The company buys a machine, which reduces cash flow but adds new capital.
- The company issues shares, which increases equity and liquidity in tandem.
As long as the balance sheet remains balanced, the financial position of the company makes sense. An overweight assessment one side or the other indicates an accounting problem that requires an audit to rectify it. The record must live up to its nickname.
What is this for?
Balance sheets are a great window into the overall financial health of a business. Executives and investors can see, at a glance, what the company owns and owes, and a widespread breakdown of those numbers. Ultimately, the balance sheet shows the equity in a business.
A balance sheet can also indicate a company’s short-term financial capabilities. For example, does he have enough cash to pay his future debts? Is it paying an appropriate dividend based on the balance sheet or is it in danger? What is the company’s debt ratio? These questions all provide context for investors when assessing the prospects for investing in a company.
What can’t a balance sheet tell you?
While balance sheets provide an excellent overview of the financial health of the business, they are not indicative of trends. There is no perspective on cash flow, for example. An otherwise healthy balance sheet could mask the fact that the business has irregular cash flows and problems managing accounts receivable and payable.
Balance sheets are also relatively easy to manipulate thanks to creative (but legal) accounting practices. For example, some companies will write down inventory to improve the balance sheet without showing improved sales numbers.
The balance sheet is best examined in tandem with the statements of operations and cash flows. These other financial reports provide important context for the assets, liabilities and equity on the balance sheet.
Where to find a company’s balance sheet
The Securities and Exchange Commission (SEC) requires public companies to regularly file balance sheet statements. Investors can find this information in the company’s 10-K and 10-Q documents. These documents will also include other financial documents, such as income statements.
The use of balance sheet information from a company’s 10-K or 10-Q comes with assurance of financial accuracy. A third-party external auditor verifies their accuracy and truthfulness. This means you can expect GAAP compliance and independently certified financial data. Investors can generally take these numbers at face value, pending an unqualified (or qualified) audit opinion.
Familiarize yourself with the balance sheet
Balance sheets are one of the fundamental financial reports that every investor should be familiar with. Fortunately, they are easy to read and understand with a little practice. And what’s more, you can use these reports to determine if the business is a good investment for you. For more stock advice, subscribe to Trade of the day e-letter below. This daily newsletter provides stock market advice, trends and picks from Wall Street experts with decades of experience.
Familiarizing yourself with a balance sheet means being able to draw conclusions about the financial health of a company and its future wealth prospects. This, in turn, helps investors identify investment opportunities and avoid pitfalls. Check a company’s balance sheet as often as it publishes one to identify changes that show positive trends in net worth or negative trends in debt and equity.