How To Study A Company's Balance Sheet

A company's balance sheet gives you a financial snapshot of what the company looks like in terms of the following equation: Assets - liabilities = net worth. By looking at a company's balance sheet, you can address the following questions:

What does the company own (assets)? The company can own assets, which can be financial, tangible, and/or intangible. Assets can be anything that has value or that can be converted to or sold for cash. Financial assets can be cash, investments, or accounts receivable. Assets can be tangible things such as inventory, equipment, and/or buildings. They can also be intangible things such as licenses, trade-marks, or copyrights.

What does the company owe (liabilities)? Liabilities are anything of value that the company must ultimately pay to someone else. Liabilities can be invoices (accounts payable) or short-term or long-term debt.

What is the company's net equity (net worth)? After you subtract the liabilities from the assets, the remainder is called either net worth, net equity, or net stockholders' equity. This is also the critical number when calculating a company's book value.

As you can see, a balance sheet is not difficult to understand. It is an important document that you should look at carefully to make sure the company is in a strong financial position. Fortunately, we live in the age of information, so finding the relevant financial data on a company isn't difficult.

The assets and liabilities relationship for a company has the same logic as the assets and liabilities in your own household. When you look at a snapshot of your own finances (your personal balance sheet), how can you tell if you're doing well? Odds are that you would start by comparing some numbers. If your net worth was $5,000, you might say, "That's great!" But a more appropriate remark would be something like, "That's great compared to, say, a year ago."

You need to compare the company's balance sheet at a recent point in time to a past time. You should do this comparative analysis with all the key items on the balance sheet. You do this to see the company's progress. Is it growing its assets and/or shrinking its debt? Most importantly, is the company's net worth growing? Is it growing by at least 10 percent from a year ago? All too often, investors stop doing their homework after they make an initial investment. You should continue to look at the company's numbers on a regular basis so that you can be ahead of the curve. If the company starts to have problems, you can get out before the rest of the market starts getting out, which will cause the stock price to fall.