GOBankingRates

How To Read a Balance Sheet To Guide Your Investment Decisions

Cheryl Savan / Shutterstock.com

A balance sheet is one of many financial documents that publicly traded companies are required to file with the government and make available to investors. At its most basic level, a balance sheet can help you gauge a company’s ability to pay for its near-term operating needs, meet future debt obligations and make distributions to owners.

How a Balance Sheet Works

A balance sheet is comprised of three different parts: assets, liabilities and shareholders’ equity. Assets reflect what an entity owns, while liabilities reflect what it owes. The equity section reflects the amount of money invested in a business. All provide indicators of a company’s financial health. Here’s a further breakdown of each category:

3 Aspects of a Balance Sheet

  • Assets: These typically include items like real estate, machinery, patents, inventory and accounts receivable. Assets are broken down between current assets, which are items a company expects to convert to cash within the next year — e.g. accounts receivable and inventory; and noncurrent assets, which are items that aren’t expected to be converted to cash within a year, such as buildings and machinery.
  • Liabilities: A liability is any expense the company is obligated to pay. It typically includes mortgages, accrued taxes, purchases, loans and accrued employee salaries and benefits.
  • Shareholders’ equity: Shareholders’ equity equals assets minus liabilities. If all of the assets could be sold for book value, owners’ equity is the amount that the owners or shareholders of the company would receive after paying off all debts.

Building Wealth

A single balance sheet shows you a company’s financial position at a specific moment in time. But as an investor, you should compare different balance sheets to see how that position has changed over time.

Signs of a Weak Balance Sheet

When a company is struggling financially, you can usually find evidence of it in the balance sheet. Here are some things to look for:

Building Wealth

Signs of a Strong Balance Sheet

A balance sheet also can let you know when a company is doing well. Here are a couple of key indicators of strength:

The Bottom Line

Balance sheets can’t tell you everything about a company. For that, you’ll have to look at other financial documents like the income statement, cash flow statement and statement of shareholder’s equity. But a balance sheet can give you a decent snapshot of a company’s overall financial condition. Just remember to compare different periods to get the best indication of how the company has performed over the course of a few years.

Building Wealth

Click to read a beginner’s guide to investing in stocks.

Michael Keenan contributed to the reporting for this article.