The Beginner’s Guide to Balance Sheets

A balance sheet is a financial statement that reports on a company’s assets, liabilities and shareholder equity between a specific period. The balance sheet summarizes what the company owns, owes and amount invested by shareholders.

It is called a “balance sheet” because Assets will always balance with Liabilities + Shareholder Equity. This formula is intuitive: a company has to pay for all the things it owns (assets) by either borrowing money (taking on liabilities) or taking it from investors (issuing shareholders’ equity).

Assets

Assets are resources that the company owns. Examples include cash, inventory or property. Assets are divided by current assets, which are assets that can be easily converted to cash within a year and non-current or long-term assets.

Current Assets

  • Cash and Cash Equivalents: are the most liquid assets and can include Treasury bills and short-term certificates of deposit, as well as hard currency.
  • Marketable Securities: money that customers owe the company, perhaps including an allowance for doubtful accounts since a certain proportion of customers can be expected not to pay.
  • Inventory:  goods available for sale, valued at the lower of the cost or market price.
  • Prepaid Expenses: represent the value that has already been paid for, such as insurance, advertising contracts or rent.

Long-Term Assets

  • Long-Term Investments: these could be stocks, bonds, real estate that the company plans to keep for at least a year
  • Fixed Assets: include land, machinery, equipment, buildings and other durable, generally capital-intensive assets.
  • Intangible Assets: include non-physical (but still valuable) assets such as intellectual property and goodwill. In general, intangible assets are only listed on the balance sheet if they are acquired, rather than developed in-house.

Liabilities

Liabilities aredebt that the company owes. Examples of this includes rent, wages and utilities. Similar to assets, liabilities are split into current liabilities which are debts that are due within a year and long-term liabilities.

Current Liabilities:

  • Current portion of long-term debt
  • Bank indebtedness
  • Interest payable
  • Rent, tax, utilities
  • Wages payable
  • Customer prepayments
  • Dividends payable and others

Long Term Liabilities

  • Long-term debt: interest and principal on bonds issued
  • Pension fund liability: the money a company is required to pay into its employees’ retirement accounts
  • Deferred tax liability: taxes that have been accrued but will not be paid for another year m Liabilities

Shareholder Equity

Shareholder represents the investment by shareholders. Retained earnings are the net earnings a company either reinvests in the business or use to pay off debt; the rest is distributed to shareholders in the form of dividends. To learn more about dividends: The Beginner’s Guide to Dividends

Balance Sheet Ratios

Balance sheet ratios are financial metrics that determine relationships between different aspects of a company’s financial position. The ratios will determine a company’s liquidity (how quickly a company can turn assets to cash) and solvency (ability to pay off debt).

Quick Ratio (Current Assets – Inventories) / Current Liabilities: The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets. The higher the quick ratio, the better the position of the company.

A result of 1 is considered to be the normal quick ratio, as it indicates that the company is fully equipped with exactly enough assets to be instantly liquidated to pay off its current liabilities. A company that has a quick ratio of less than 1 may not be able to fully pay off its current liabilities in the short term, while a company having a quick ratio higher than 1 can instantly get rid of its current liabilities.

Current Ratio = Current Assets / Current Liabilities: simpler variant to the quick ratio and is used to determine the company’s ability to pay back its short term liabilities.

If the ratio is below 1, it raises a warning sign as to whether the company is able to pay its short term obligations when due. If a company has a low current ratio year after year, it could be a characteristic of the industry where companies operate and high debt levels.

Debt to Equity Ratio (Debt to Equity Ratio = Total Liabilities / Shareholders Equity): The objective of this financial ratio is to determine how a company has been financing its growth. A high ratio means that the company has been growing due to debt. Not all debt is bad, but if the number is exceedingly high, remember that the company has to pay off the loan as well as interest payments.

Other Important Ratios:

Days Sales Outstanding = (Receivables / Revenue) x 365: Cash is king and a business capable of converting its receivables into cash quickly is a great sign of health and efficiency.

A low DSO number means that it takes a company fewer days to collect its accounts receivable. A high DSO number shows that a company is selling its product to customers on credit and taking longer to collect money.

Days Inventory Outstanding = (Inventory / COGS) x 365: This financial ratio is used to measure the average number of days a company holds inventory before selling it.

This ratio is industry specific and should be used to compare competitors. A company like Boeing will have vastly different DIO than a company like Amazon where inventory turnover is high.

Inventory Turnover = COGS / Average of Inventory: Inventory is money. It costs money to buy, it costs money to just hold it because it takes up a lot of overhead if it isn’t cleared out. You waste shelf space, the product gets old and it may have to be sold at a fraction of the price just to get rid of it.

Inventory turnover is important for companies with physical products and is best used to compare against peers.

Inventory to Sales = Inventory / Revenue: The objective is to see how inventory is being managed as it will signal potential problems with cash flow. An increase in the inventory to sales ratio can indicate that the investment in inventory is growing more rapidly than sales or sales are decreasing.

Where to Find Balance Sheet Data?

Yahoo Finance is a great resource to get access to financial data for the past 4 years. You’ll be able to find each line item on the balance sheet, income statement or cash flow statements.

Another tool I highly recommend is TradingView. With this platform, you are able to track its historical stock prices with different financial metrics.

Related

The Future of Stock News

We are launching a news platform that filters out the noise and shows only the most relevant and important news to you.