If you often have the question, “ How to Read A Company’s Balance Sheet?”, then this is the blog for you.
Reading a company’s balance sheet is crucial not only for Investors, business owners, investors, entrepreneurs, managers, finance students, and employees in leadership roles. Before investing in a company it's important to analyze different aspects of the asset they’re considering. Both fundamental analysis and reference to charts and historical data are required before making investment decisions.
In this blog, we will learn how to read a company's balance sheet for profitable investment. Here is the synopsis of what you will learn in this blog.
> What is a balance sheet?
> What Is The Purpose Of A Balance Sheet?
> How to Read A Company’s Balance Sheet?
Read this guide completely to understand each aspect carefully and then try to analyze the balance sheets of some companies to understand it completely.
The balance sheet is the financial statement prepared at the end of every financial year by the companies. It shows a complete picture of a company’s financial journey. Along with the income statement and cash flow statement, the balance sheet forms the foundation of the company’s financial health
You will know about the firm's liability, assets, and owner’s net worth once you learn how to analyze a company’s balance sheet. It's the balance sheet that will help you decide whether the company or organization is worth investing or not. You will be able to understand how the company has been performing from its inception.
The function of the balance sheet is to list out and tally up all the assets of a company, the liabilities, and the owner's equity. The balance sheets are prepared and distributed usually on a quarterly or yearly basis depending upon the frequency of reporting and according to the law of the company. By looking at a balance sheet we can determine how a company handles its finance The balance sheet can be used to find the company’s book value.
The main purpose of the balance sheet is to list and add up everything the company owns (assets), owes (liabilities), and what’s left for the owners (equity). Companies usually prepare balance sheets quarterly or monthly, depending on how often they report and the legal requirements. By reviewing a balance sheet, you can see how well a company manages its finances.
With the help of the balance sheet shareholders and employees can analyze whether a company is in loss or profit during the internal reviewing process. Shareholder makes their decisions as per their conclusions after an internal review.
During external reviewing the potential investor will have a clear idea of the available resources of the company and how they are financed. For example, if a company has an asset plant and machinery of 20 lakhs and a debt of 20 lakhs, it is possible the debt was taken to buy the plant and machinery. With the help of the balance sheet, the external auditors can make sure that the company is following the rules and laws.
The balance sheet gives information about the company’s past performance. Investors can get a clear idea of whether they should invest in the company or not. However, there is no guarantee that the future performance will be based on past performance
You need to look for 3 main parts when reading a balance sheet - Assets, Liabilities, and Owners Equity. The balance sheet follows the Equation of the double entry system Assets Liabilities + Owner’s Equity, and make sure that both the Left side and the right side of the equation are always balanced.
The sections of assets and liabilities are arranged by how current the account is. On the asset side, the accounts are classified from the most liquid to the least liquid. On the liabilities side, they are arranged from short to long-term debts and other obligations.
If a company has more assets than liabilities then the company is performing well. It also indicates a strong balance sheet. Balance sheets depict a company’s health.
How can an Investor evaluate a company's financial performance?
Investors can evaluate a company's financial performance by using tools such as
|
Ratio |
Description |
Formula |
||
|
Gross Profit Margin |
Indicates the percentage of revenue left after deducting the cost of goods sold (COGS). |
(Revenue - COGS) / Revenue × 100 |
||
|
Net Profit Margin |
Measures the percentage of revenue remaining as profit after all expenses are deducted. |
Net Profit / Revenue × 100 |
||
|
Working Capital |
Shows a company's short-term liquidity and operational efficiency. |
Current Assets - Current Liabilities |
||
|
Current Ratio |
Evaluates the ability to cover short-term liabilities with short-term assets. |
Current Assets / Current Liabilities |
||
|
Quick Ratio |
Assesses the ability to meet short-term obligations with liquid assets (excluding inventory). |
(Current Assets - Inventory) / Current Liabilities |
||
|
Leverage |
Measures the extent to which a company is using debt to finance its operations. |
Total Debt / Total Equity |
||
|
Debt-to-Equity Ratio |
Indicates the proportion of debt financing relative to equity financing. |
Total Debt / Shareholder’s Equity |
||
|
Inventory Turnover |
|
Cost of Goods Sold (COGS) / Average Inventory |
These tools are called financial ratios we have already discussed these in detail in our previous blogs, you can go through them on our website
Investors must know how to read a company’s balance sheet to be profitable in the long run. Reading a balance sheet eventually comes with practice hence it is suggested to go through the balance sheets of top-performing companies after reading this blog. For a better understanding watch the live sessions on our Youtube channel.
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