With a greater understanding of the balance sheet and how it is constructed, we can look now at some techniques used to analyze the information contained within the balance sheet. The main way this is done is through financial ratio analysis.
- 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 they are leveraged. This 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.
The balance sheet, along with the income and cash flow statements, is an important tool for investors to gain insight into a company and its operations. The balance sheet is a snapshot at a single point in time of the company’s accounts - covering its assets, liabilities and shareholders’ equity. The purpose of the balance sheet is to give users an idea of the company’s financial position along with displaying what the company owns and owes. It is important that all investors know how to use, analyze and read this document.
by Investopedia Staff, (Contact Author | Biography)