How Do You Read a Balance Sheet? (2024)

A company's balance sheet, also known as a "statement of financial position," reveals the firm's assets, liabilities,and owners' equity (net worth) at a specific point in time. The balance sheet, together with the income statement and cash flow statement, make up the cornerstone of any company's financial statements.

If you are a shareholder of a company or a potential investor, it is important to understand how the balance sheet is structured, how to read one, and the basics of how to analyze it.

Key Takeaways

  • The balance sheet is a key financial statement that provides a snapshot of a company's finances.
  • The balance sheet is split into two columns, with each column balancing out the other to net to zero.
  • The left side records a firm's itemized assets, categorized as long-term vs. short-term.
  • The right side contains a firm's liabilities and shareholders' equity, also separated as long-term vs. short-term.
  • Equity is the remainder value when liabilities are subtracted from assets.

How Do You Read a Balance Sheet? (1)

How the Balance Sheet Works

The balance sheet is divided into two parts that, based on the following equation, must equal each other or balance each other out. The main formula behind a balance sheet is:

Assets = Liabilities + Shareholders' Equity

This means that assets, or the means used to operate the company, are balanced by a company's financial obligations, along with the equity investment brought into the company and its retained earnings.

Assets are what a company uses to operate its business, while its liabilities and equity are two sources that support these assets. Owners' equity, referred to as shareholders' equity, in a publicly traded company, is the amount of money initially invested into the company plus any retained earnings, and it represents a source of funding for the business.

The balance sheet is broken into two main areas. Assets are on the top or left, andbelow them or to the right arethe company's liabilities and shareholders' equity. A balance sheet is also always in balance, where the value of the assets equals the combined value of the liabilities and shareholders' equity.

Within each section, the assets and liabilities sections of the balance sheet are organized by how current the account is. So for the asset side, the accounts are classified typically from most liquid to least liquid. For the liabilities side, the accounts are organized from short- to long-term borrowings and other obligations.

It is important to note that a balance sheet is just a snapshot of the company's financial position at a single point in time.

Types of Assets

Current (Short-Term) Assets

Current assets have a lifespan of one year or less, meaning they can be converted easily into cash. Such asset classes include cash and cash equivalents, accounts receivable,and inventory.

Cash, the most fundamental of current assets, also includes non-restricted bank accounts and checks. Cash equivalents are very safe assets that can be readily converted into cash; U.S. Treasuries are one such example.

Accounts receivables (AR) consist of the short-term obligations owed to the company by its clients. Companies often sell products or services to customers on credit; these obligations are held in the current assets account until they are paid off by the clients.

Lastly, inventory represents the company's raw materials, work-in-progress goods,and finished goods. Depending on the company, the exact makeup of the inventory account will differ. For example, a manufacturing firm will carry a large number of raw materials, while a retail firm carries none. The makeup of a retailer's inventory typically consists of goods purchased from manufacturers and wholesalers.

Non-Current (Long-Term) Assets

Non-current assets are assets that are not turned into cash easily, are expected to be turned into cash within a year, and/or have a lifespan of more than a year. They can refer to tangible assets, such as machinery, computers, buildings, and land. Non-current assets also can be intangible assets,such as goodwill, patents, or copyrights. While these assets are not physical in nature, they are often the resources that can make or break a companythe value of a brand name, for instance, should not be underestimated.

Depreciation is calculated and deducted from most of these assets, which represents the economic cost of the asset over its useful life.

Types of Liabilities

On the other side of the balance sheet are the liabilities. These are the financial obligations a company owes to outside parties. Like assets, they can be both current and long-term.

Current (Short-Term) Liabilities

Current liabilities are the company's liabilities that will come due, or must be paid, within one year. This includes both shorter-term borrowings, such as accounts payables (AP), which are the bills and obligations that a company owes over the next 12 months (e.g., payment for purchases made on credit to vendors).

The current portion of longer-term borrowing, such as the latest interest payment on a 10-year loan, is also recorded as a current liability.

Non-Current (Long-Term) Liabilities

Long-term liabilities are debts and other non-debt financial obligations, which are due after a period of at least one year from the date of the balance sheet. For instance, a company may issue bonds that mature in several years' time.

Shareholders' Equity

Shareholders' equity is the initial amount of money invested in a business. If at the end of the fiscal year, a company decides to reinvest its net earnings into the company (after taxes), these retained earnings will be transferred from the income statement onto the balance sheet and into the shareholder's equity account.

This account represents a company's total net worth. In order for the balance sheet to balance, total assets on one side have to equal total liabilities plus shareholders' equity on the other side.

How to Read a Balance Sheet

Below is an example of a corporate balance sheet for Walmart from FY 2022:

How Do You Read a Balance Sheet? (2)

Source: Walmart.

As you can see from the balance sheet above, Walmart had a large cash position of $14.76 billion in 2022, and inventories valued at over $56.5 billion. This reflects the fact that Walmart is a big-box retailer with its many stores and online fulfillment centers stocked with thousands of items ready for sale. This is matched on the liabilities side by $55.2 billion in accounts payable, likely money owed to the vendors and suppliers of many of those goods.

Subtracting total liabilities from total assets, Walmart had a large positive shareholders' equity value, over $83.2 billion.

Analyzing a Balance Sheet With Ratios

With a greater understanding of a balance sheet and how it is constructed, we can review some techniques used to analyze the information contained within a balance sheet. The main technique is financial ratio analysis.

Financial ratio analysis uses formulas to gain insight into a company and its operations. For a balance sheet, using financial ratios (like the debt-to-equity (D/E) ratio) can provide a good sense of the company's financial condition, along with its operational efficiency. It is important to note that some ratios will need information from more than one financial statement, such as from the balance sheet and the income statement.

Looking at Walmart's balance sheet above, we can see that the debt-to-equity ratio for 2022 was:

D/E = Total Liabilities / Total Shareholders' Equity = $152,969 / 83,253 = 1.84.

The resultmeans that WMT had$1.84of debt for every dollar of equity value. Generally speaking, a D/E ratio under 2.0 is favorable.

Important ratios that use information from a balance sheet can be categorized as liquidity ratios, solvency ratios, financial strength ratios, and activity ratios. Liquidity and solvency ratios show how well a company can pay off its debts and obligations with existing assets. Financial strength ratios, such as the working capital and debt-to-equity ratios, provide information on how well the company can meet its obligations and how the obligations are leveraged. These ratios can give investors an idea of how financially stable the company is and how the company finances itself. Activity ratios focus mainly on current accounts to show how well the company manages its operating cycle (which include receivables, inventory, and payables). These ratios can provide insight into the company's operational efficiency.

What Can You Tell From Looking at a Company's Balance Sheet?

Balance sheets give an at-a-glance view of the assets and liabilities of the company and how they relate to one another. The balance sheet can help answer questions such as whether the company has a positive net worth, whether it has enough cash and short-term assets to cover its obligations, and whether the company is highly indebted relative to its peers. Fundamental analysis using financial ratios is also an important set of tools that draw their data directly from the balance sheet.

What Are the Main Things Found on a Balance Sheet?

The balance sheet includes information about a company’s assets and liabilities, and the shareholders' equity that results. These things might include short-term assets, such as cash and accounts receivable, inventories, or long-term assets such as property, plant, and equipment (PP&E). Likewise, its liabilities may include short-term obligations such as accounts payable to vendors, or long-term liabilities such as bank loans or corporate bonds issued by the company.

Does a Balance Sheet Always Balance?

Yes, the balance sheet will always balance since the entry for shareholders' equity will always be the remainder or difference between a company's total assets and its total liabilities. If a company's assets are worth more than its liabilities, the result is positive net equity. If liabilities are larger than total net assets, then shareholders' equity will be negative.

The Bottom Line

A balance sheet, along with the income and cash flow statement, is an important tool for investors to gain insight into a company and its operations. It is a snapshot at a single point in time of the company's accountscovering its assets, liabilities, and shareholders' equity. The purpose of a balance sheet is to give interested parties an idea of the company's financial position, in addition to displaying what the company owns and owes. It is important that all investors know how to use, analyze and read a balance sheet. A balance sheet may give insight or reason to invest in a stock.

How Do You Read a Balance Sheet? (2024)

FAQs

What does a balance sheet tell you? ›

The balance sheet provides information on a company's resources (assets) and its sources of capital (equity and liabilities/debt). This information helps an analyst assess a company's ability to pay for its near-term operating needs, meet future debt obligations, and make distributions to owners.

How do you Analyse a balance sheet? ›

The strength of a company's balance sheet can be evaluated by three broad categories of investment-quality measurements: working capital, or short-term liquidity, asset performance, and capitalization structure. Capitalization structure is the amount of debt versus equity that a company has on its balance sheet.

What do the numbers on a balance sheet mean? ›

What are the numbers on a balance sheet? Balance sheets list three types, sections, or groups of numbers: first are assets, then liabilities, and finally, equity. Assets are things of value owned by the company. Liabilities include all the company's financial obligations, from debt, taxes, payables, and payroll.

What goes first in a balance sheet? ›

More liquid items like cash and accounts receivable go first, whereas illiquid assets like inventory will go last. After listing a current asset, you'll then need to include your non-current (long-term) ones. Don't forget to include non-monetary assets as well.

What is the most important part of the balance sheet? ›

Many experts believe that the most important areas on a balance sheet are cash, accounts receivable, short-term investments, property, plant, equipment, and other major liabilities.

What does a balance sheet not tell you? ›

The balance sheet reveals a picture of the business, the risks inherent in that business, and the talent and ability of its management. However, the balance sheet does not show profits or losses, cash flows, the market value of the firm, or claims against its assets.

Do expenses go on a balance sheet? ›

A balance sheet includes assets, liabilities and equity. An income statement includes revenue, expenses, gains and losses. Time frame. A balance sheet shows information for a specific point in time.

What does a healthy balance sheet look like? ›

A balance sheet should show you all the assets acquired since the company was born, as well as all the liabilities. It is based on a double-entry accounting system, which ensures that equals the sum of liabilities and equity. In a healthy company, assets will be larger than liabilities, and you will have equity.

Which is more important income statement or balance sheet? ›

However, many small business owners say the income statement is the most important as it shows the company's ability to be profitable – or how the business is performing overall. You use your balance sheet to find out your company's net worth, which can help you make key strategic decisions.

How to tell if a company is profitable from a balance sheet? ›

The two most important aspects of profitability are income and expenses. By subtracting expenses from income, you can measure your business's profitability.

What are the golden rules of accounting? ›

Every economic entity must present accurate financial information. To achieve this, the entity must follow three Golden Rules of Accounting: Debit all expenses/Credit all income; Debit receiver/Credit giver; and Debit what comes in/Credit what goes out.

What are the three main ways to analyze financial statements? ›

Financial accounting calls for all companies to create a balance sheet, income statement, and cash flow statement, which form the basis for financial statement analysis. Horizontal, vertical, and ratio analysis are three techniques that analysts use when analyzing financial statements.

How to analyse balance sheet and profit and loss statement? ›

Use these seven steps to help you read and analyze a P&L report:
  1. Define the revenue. ...
  2. Understand the expenses. ...
  3. Calculate the gross margin. ...
  4. Calculate the operating income. ...
  5. Use budget vs. ...
  6. Check the year-over-year (YoY) ...
  7. Determine net profit.
Mar 10, 2023

How do you Analyse an income statement and balance sheet? ›

In other words, the balance sheet shows what you own (assets) and what you owe (liabilities) at a moment in time (most often as of December 31). The income statement shows what happens over a period of time (usually a year): what comes in, what goes out, and what's left over at the end.

Top Articles
Latest Posts
Article information

Author: Barbera Armstrong

Last Updated:

Views: 5343

Rating: 4.9 / 5 (59 voted)

Reviews: 90% of readers found this page helpful

Author information

Name: Barbera Armstrong

Birthday: 1992-09-12

Address: Suite 993 99852 Daugherty Causeway, Ritchiehaven, VT 49630

Phone: +5026838435397

Job: National Engineer

Hobby: Listening to music, Board games, Photography, Ice skating, LARPing, Kite flying, Rugby

Introduction: My name is Barbera Armstrong, I am a lovely, delightful, cooperative, funny, enchanting, vivacious, tender person who loves writing and wants to share my knowledge and understanding with you.