Reading The Balance Sheet

As you can see from the balance sheet above, it is broken into two sides. Assets are on the left side and the right side contains the company’s liabilities and shareholders’ equity. It is also clear that this balance sheet is in balance where the value of the assets equals the combined value of the liabilities and shareholders’ equity.

Another interesting aspect of the balance sheet is how it is organized. 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.

Analyze the Balance Sheet With Ratios
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 ratio analysis uses formulas to gain insight into the company and its operations. For the balance sheet, using financial ratios (like the debt-to-equity ratio) can show you a better idea 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.

The main types of ratios that use information from the balance sheet are financial strength ratios and activity ratios.

• 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.

There are a wide range of individual financial ratios that investors use to learn more about a company. (To learn more about ratios and how to use them, see our Ratio Tutorial.)

Conclusion
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)

http://www.investopedia.com/articles/04/031004.asp