As a trader a company’s balance sheet offers the best insight into the company if you are able to read it properly. There are a few good figures on a company’s balance sheet which can be used to calculate a few ratios, which can clearly indicate if the company is robust in its functions or is just existing. However, balance sheet alone cannot give you the whole picture. It has to be studied in conjunction with income and cash flow statement to interpret the whole picture.
A balance sheet contains information on the assets, liabilities and equity statement of the company. The three components are related as: Assets = Liabilities + Owner’s equity
Assets include current and non-current assets. Cash, inventory, prepaid expenses are all current assets. Current assets basically pertain to short-term assets i.e. which will be held up for up to one- year. They are mostly financed by working capital. If a company holds a lot of current assets, more than usual then it could be an indication that they are using up a lot of cash in day to day operations. Non-current or fixed assets include machinery, property, patents and long-term investments. These assets are created one –time and will exist for a long time frame.
Liabilities include current and non-current liabilities. Liabilities pertain to obligations which company needs to fulfill. It ranges from the debt owed to creditors to the payable salary to employees. Sometimes current liabilities can be an indicator that company has employed too many or too less people to accomplish the tasks. Current liabilities are supposed to be fulfilled within a period of twelve months. Non-current liabilities include long-term debt from the banks.
Owner’s equity comprises of Retained earnings and treasury stock. Retained earnings is the amount of cash left with the company after dividend has been paid out to the shareholders. Sometimes, this can be negative. In that case it is termed as a deficit. This applies only to companies which are listed on stock exchanges and have shares up for sale in the market. Treasury stock is the stock which was issued by the company but was re-purchased by them probably due to low price of the share in the market. Sometimes, companies do this also to increase their earnings per share, and thus make their share appear more profitable in the market. Due to repurchase, the number of shares outstanding in the market decrease and this shoots up the earning per share.
Companies publish their balance sheet regularly in the various financial newspapers and the titles mentioned above can be tracked in it word-by-word. The above information along with a few ratios like current ratio and others can paint a picture about the financial health of the company. Your broker will be able to help well if you can understand basic financial terms. Understanding a company’s balance sheet could be your first step towards helping your broker and yourself in making better investment decisions.