Understanding A Company’s Balance Sheet To Make You A Better Investor

by Hank Coleman

accountingThe balance sheet is one of the most important financial statements of a company.  In the investing world, a balance sheet is a statement of a company’s financial position and a summary of the organization’s account balances. A balance sheet is often described as a snapshot of a company’s financial condition at a certain moment in time, the assets, liabilities and ownership equity as of a specific date, such as the end of its financial year. The main purpose behind producing a balance sheet is to make sure that the asset and liability accounts are always in balance and that the company funds are properly accounted for under Generally Accepted Accounting Procedures (GAAP) which is the accounting standards for publicly traded companies in the United States. Investors come to know the performance and status of the company through its balance sheet. This may be produced quarterly, semi- annually, or even monthly as well, depending on regulatory requirements.

The balance sheet includes the following main points:

  • What the company owns also called assets
  • What the company owes, its liabilities
  • The value of the business to its stockholders – equity

I always remember my freshman account professor’s first lesson that assets minus liabilities always equal stockholders’ equity.  It is the universal accounting equation.

Why should the balance sheet be so important to an investor?

As an investor it is necessary to ensure that the company has good potential and future prospects. The balance sheet helps you get answers to questions like:

  • Should the firm be able to meet its financial obligations?
  • What amount of funds have already been invested in this company?
  • How much debt does the company have on its books?
  • What are the different assets that the company has purchased with its financing?

These are just a few of the many relevant questions an investor should consider when studying a company’s balance sheet. The balance sheet provides a diligent investor with many clues and guidelines to a company’s future performance. By simply identifying and analyzing trends, a balance sheet provides a quick preview of the financial strength and capabilities of a business. The balance sheet, along with the income statement and the statement of cash flows are the three most important reports included in a public company’s Annual Report which is the cornerstone of reporting data that potential lenders such as banks, investors, and vendors us to consider the viability of a company.

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