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Download balance sheet template in Microsoft Excel format.
Determining Financial Strength and Efficiency with Proper Balance Sheet Analysis
Are you considering making a business investment by buying shares of stock in a publicly traded company? Are you familiar with balance sheet analysis, a technique that can help you determine the financial strength of a company? A company’s balance sheet can provide valuable insight if you know what to look for, and should always be analyzed thoroughly before making any investment decision. In this article we will briefly define what a balance sheet is and its purpose, and provide a few balance sheet analysis tips that may help you make more informed investment decisions.
What Is the Purpose of a Balance Sheet?
Also known as a statement of financial position, the balance sheet is one of three key documents that comprise an organization’s financial statements. In essence, the balance sheet is a detailed list of a company’s assets, both current and long-term, along with its long and short-term liabilities and the owner’s equity. Much like the name implies, a balance sheet shows how the totality of a company’s assets balance or are equal to the sum of the companies liabilities and the equity held by its shareholders.
Typically, the balance sheet is formatted as a two-column document that lists the assets on the left and the liabilities and equity on the right. Assets are listed with the most current assets on top, which are the assets that have a lifespan of less than a year before they will be converted into cash, followed by long-term assets with a lifespan of one year or more before they will be liquidated.
The right side of the balance sheet will first list the current liabilities, which are the debts that need to be paid within the year, followed by long-term liabilities with a maturity date more than one year away. Underneath the liabilities, the equity would then be listed, which is the total shareholder’s stock or the owner’s net worth.
When the assets are tallied on the left and the liabilities and equities on the right, the two resulting figures should be identical, or balance.
Balance Sheet Analysis
The most popular form of balance sheet analysis is performed using financial ratios. This technique can give investors valuable insight into a company’s financial strength and the efficiency of its daily operations. There are essentially two categories in this type of balance sheet analysis:
• Financial Strength Ratios. Financial strength ratios, which could include working capital ratios and debt-to-equity ratios, provide a snapshot view of how equipped an organization is to meet its financial obligations and to what extent a company is financially leveraged. This is a crucial balance sheet analysis tool as it gives investors a clear picture of an organization’s stability and how the company is financed.
• Financial Activity Ratios. Financial activity ratios focus more on an organization’s operational efficiency. By examining current accounts, activity ratios can show investors how well a company manages its day-to-day operations, which can include its account receivables, account payables and its inventory.
Whether you decide to use financial strength ratios, financial activity ratios or a combination of the two, performing a balance sheet analysis before you make an investment decision is always the recommended strategy.