A balance sheet is one of the three essential financial statements every investor should know how to read. It gives you a snapshot of a company's financial health at a specific moment in time. In this guide, we will break down every part of a balance sheet so you can analyze any company with confidence.
What is a Balance Sheet?
A balance sheet shows what a company owns (assets), what it owes (liabilities), and what is left over for shareholders (equity). It is called a balance sheet because it must always balance: Assets equals Liabilities plus Shareholders Equity.
The Balance Sheet Equation: Assets = Liabilities + Shareholders Equity. This equation must always be true. If it does not balance, there is an error somewhere.
The Three Main Sections
1. Assets: What the Company Owns
Assets are everything the company owns that has value. They are divided into two categories based on how quickly they can be converted to cash.
Current Assets
These are assets that can be converted to cash within one year:
- Cash and cash equivalents: Money in the bank and short-term investments
- Accounts receivable: Money customers owe the company
- Inventory: Products ready to sell or materials to make products
- Prepaid expenses: Bills paid in advance like insurance or rent
Non-Current Assets
These are long-term assets that will provide value for more than one year:
- Property, plant, and equipment: Buildings, machinery, vehicles
- Intangible assets: Patents, trademarks, goodwill
- Long-term investments: Stocks or bonds held for more than a year
Example: Apple Inc. Assets
Looking at Apple's balance sheet, you might see:
- Cash and equivalents: $29 billion
- Accounts receivable: $28 billion
- Inventory: $6 billion
- Property and equipment: $43 billion
- Total Assets: $352 billion
2. Liabilities: What the Company Owes
Liabilities are all the debts and obligations the company must pay. Like assets, they are divided into current and non-current.
Current Liabilities
Debts that must be paid within one year:
- Accounts payable: Money owed to suppliers
- Short-term debt: Loans due within a year
- Accrued expenses: Wages, taxes, and interest owed
- Deferred revenue: Payments received for products not yet delivered
Non-Current Liabilities
Long-term obligations due after one year:
- Long-term debt: Bonds and loans due in more than a year
- Pension obligations: Future payments to retired employees
- Deferred tax liabilities: Taxes owed in the future
3. Shareholders Equity: What is Left for Owners
Shareholders equity is the company's net worth. It is what would be left if the company sold all its assets and paid all its debts.
- Common stock: Money received from selling shares
- Retained earnings: Profits kept in the company over time
- Treasury stock: Shares the company bought back (reduces equity)
How to Analyze a Balance Sheet
Now that you understand the components, here is how to use them to evaluate a company.
Step 1: Check the Current Ratio
Divide current assets by current liabilities. A ratio above 1.5 means the company can easily pay its short-term debts.
Step 2: Look at the Debt Levels
Compare total debt to total equity. A high debt to equity ratio means the company is heavily leveraged, which increases risk.
Step 3: Track Changes Over Time
Compare balance sheets from multiple years. Is debt growing faster than assets? Are retained earnings increasing? These trends tell you if the company is getting stronger or weaker.
Step 4: Compare to Competitors
A balance sheet only tells part of the story. Compare ratios to other companies in the same industry to see how they stack up.
Red Flags to Watch For
- Current ratio below 1.0 (may struggle to pay bills)
- Rapidly increasing debt without asset growth
- Declining retained earnings (company losing money)
- Large amounts of goodwill relative to total assets
- Accounts receivable growing faster than revenue
Balance Sheet vs Income Statement
The balance sheet shows a snapshot at one point in time. The income statement shows performance over a period. You need both to get the full picture. A profitable company on the income statement might still have balance sheet problems if it is loaded with debt.
Common Balance Sheet Metrics
- Working capital: Current assets minus current liabilities
- Book value: Total shareholders equity
- Book value per share: Shareholders equity divided by shares outstanding
- Debt to equity ratio: Total liabilities divided by shareholders equity
Analyze Balance Sheets Faster
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Summary
Reading a balance sheet is a fundamental skill for any investor. Remember that assets must equal liabilities plus equity. Focus on the current ratio, debt levels, and changes over time. Compare companies in the same industry. With practice, you will be able to quickly assess any company's financial health.
Ready to learn more? Check out our guide on analyzing income statements or learn about the debt to equity ratio.