How to Read a Balance Sheet of a Company

Written by james collins
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How to Read a Balance Sheet of a Company
Use the balance sheet to determine the degree of financial leverage. (Jupiterimages/Photos.com/Getty Images)

A balance sheet provides a snapshot of a company's assets. It also provides an overview of how those assets were paid for, either by liabilities or stockholders' equity. Investors like to review the balance sheet as it helps to gauge the size of a company in comparison to its peers. It also helps to see the degree of leverage the company has taken on since financial leverage is often equated to increased risk.

Skill level:
Moderately Easy

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Instructions

  1. 1

    Review assets. The first section is assets, which is listed in order of liquidity. Liquidity measures the ease with assets can be turned into cash. Cash is always first and plant, property and equipment is usually last as it takes the longest to convert to cash. Current assets are those that will be turned into cash within one year.

  2. 2

    Look over the liability section. Liabilities are listed in order of when they will be paid. Current liabilities are debts that are expected to be paid within one year. Long-term debt is usually one of the last line items in the liabilities section as it includes debt which is due in more than one year.

  3. 3

    Scan down to the stockholders' equity section. Those assets, which are not paid for with liabilities, are paid for with equity. Equity can be preferred or common stock. This action will include a book value of these shares and provides the number of shares currently outstanding in the market.

  4. 4

    Calculate the debt-to-asset ratio. Debt is referred to as liabilities on the balance sheet. Assume debt is £65,000 and assets are £130,000. The debt to assets ratio is £65,000 divided by £130,000, or 50 per cent. This means that 50 per cent of the assets were paid for with outstanding debt. You can track this ratio over time and compare to competing companies in the same industry for additional insights.

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