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by John Jagerson

The balance sheet shows investors the value of the companies assets, liabilities (debt) and owners equity. It is called a balance sheet because total assets will always equal or balance to liabilities plus owners equity. The balance sheet shows investors the net asset (book value) of the firm. It also helps investors and owners understand how the company is financing operations whether through debt or income.

1. The first section is current and long term assets. A current asset is usually defined as cash or anything that will be turned into cash within a year. Accounts receivable is a non-cash example of a current asset. Long term assets include property, plant and equipment. The assets portion of the balance sheet is affected by changes to the cash flow statement as money is invested in long term assets or as customers run up receivables with the firm.

2. Liabilities are the second section of the balance sheet. Liabilities or debt are those obligations that the firm owes to other parties, employees or the government. Short term liabilities include anything that must be paid within a year such as accounts payable or short term notes. The liabilities section of the balance sheet shows investors how management is using debt to finance the firm's operations.

3. The third section of the balance sheet is owners equity. When owners equity is added to liabilities the sum will be equal to assets. Therefore, owners equity is the "net asset value" or the firm's book value. Some analysts will insist that intangible assets must also be excluded to arrive at a true book value for a firm. Owners equity can be reduced through dividend payments and losses.

The balance sheet will contain several individual line items but they will each fall within one of these three categories. In the image below, you can see these sections in the balance sheet for Microsoft (MSFT).

There are a few things to keep in mind about the balance sheet as you begin using them in your analysis.

1. The relative size of owners equity compared to debt can give you some insight about how a company is financing its operations. Very large debt balances can increase a firm's sensitivity to interest rate changes and credit availability.

2. Retained earnings within owners equity can be reduced by losses during the quarter. The company's performance as a function of its equity is a critical fundamental measure. You can learn more about that in this video on Return on Equity (ROE).

3. The assets portion of the balance sheet can contain large amounts of "intangible assets." Usually these assets such as goodwill are not an issue but when they become  disproportionate when compared to other current and long term assets it can be troubling. This was a major warning sign that the "roll-ups" of the early 2000's were no more than a shell game.

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3.25 Copyright (C) 2007 Alain Georgette / Copyright (C) 2006 Frantisek Hliva. All rights reserved."