How to Read a Balance Sheet

Balance sheets always have a story to tell.

They can add huge value to a company, or see a share price plummet.

Some analysts are specifically dedicated to the study of corporate results, and their analyses are used to influence major investment portfolios and asset allocation.

Even with experts on hand, everyone who owns a stocks and shares portfolio should have a basic understanding of corporate balance sheets. But in reality, most people don’t look past the bottom line.

A corporate balance sheet tells you everything you need to know about a company’s assets, its financial liabilities, and the owners’ equity at a glance.

Once you can correctly read and understand a corporate balance sheet, you can make smarter investments, and even predict market trends.

And while the average corporate report may appear daunting at first – with their reams of figures and charts, and deceptively buoyant executive statements – once you know what to look for, you will be able to sift through the info like a pro.

Read on how for our ‘cheat sheet’ guide on how to read a balance sheet in the UK, and how to use this knowledge to your advantage.

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Key things to look out for on a balance sheet

The date

The date is the first thing you should look for on any balance sheet. It takes time to put together an accurate balance sheet, so most companies will release them weeks after the period being analysed. For instance, Citigroup released its 2017 fourth quarter earnings a full 17 days after that quarter had ended[1], meaning that recently-accrued fines[2] would not (yet) have been accounted for.

If a company has not released its balance sheet within a few weeks the quarter’s end, it may be a signal that the in-house accounting is not up to scratch, or that the figures are more complex than usual.

This can be a cause for concern among risk-aware investors.

Company assets

A company’s ‘total assets’ will be displayed at the bottom of the ‘assets’ section of the balance sheet.

Whatever the figure, it should be equal to the cumulative value of the company liabilities plus owners’ equity (hence the term ‘balance’ sheet).

However, within the total assets, there are a few key figures to look out for:

  • Cash
    This is the amount of money that the company has in the bank, and can act as a form of emergency fund.Cash holdings should be relatively small, and usually make up less than ten per cent of the company’s total assets. If a company appears to be holding too much cash, it may be a sign of a stalling business model.
  • Accounts receivable
    This is the total value of all outstanding invoices and payments. Ideally, this represents approximately one month’s worth of the company’s turnover.Any more, and there may be reason to suspect a supply-chain hold up which could impact on future earnings.
  • Inventory
    The value of the company’s stock or machinery. A dynamic company will always be investing in new stock to improve the efficiency of its business model. Whereas a low inventory combined with high cash reserves could signal slowdown in the company’s growth.
  • Prepaid expenses
    Bills which have been paid in advance. For instance, a company may pre-pay its contractors to secure their services. If the prepaid expenses seem unusually high, it may indicate that the company is planning for big future changes.
  • Current assets
    This is the accumulated total of the company’s cash, accounts receivable, inventory and pre-paid expenses.
  • Property, plant and/or equipment
    Like ‘inventory’, this refers to the value of any property and heavy machinery which is fully-owned or partly-owned by the company.
  • Accumulated depreciation
    This amount should be deducted from the total value of the property, plant and/or equipment as it covers off any wear and tear which might devalue these assets.

Company liabilities

Liabilities are simply debts owed to other people or other companies.

Needless to say, the total value of the liabilities should always be less than the total value of the assets. If the liabilities are unusually high, this could be a warning sign that the company is overly-reliant on debt to supplement its cash flow.

Any liabilities will be listed in full on the balance sheet. These might include credit lines, income tax owed, and any invoices which have yet to be paid.

Owners’ equity

This figure represents how much the company’s owners (i.e. the shareholders) actually own.

This is arguably the most important figure for investors, as it details how much money is invested in the company, and offers some indication as to the profitability of the business.

If a company goes into liquidation, the owners’ equity is what remains after all the liabilities are paid. If the company is sold, acquired, or floated on another stock market, the owners’ equity is likely to increase dramatically.

[1] https://www.businessinsider.com.au/citi-fourth-quarter-earnings-q4-2018-1?r=UK&IR=T

[2] https://www.bloomberg.com/news/articles/2018-01-04/citigroup-fined-over-failure-to-fix-money-laundering-safeguards

Kathryn Gaw

Kathryn Gaw is a financial journalist based in Belfast, Northern Ireland. She has been writing about personal finance and investment trends for more than a decade, and her work has been featured in the Financial Times, City A.M., the Press Association, and The Irish Independent, among many other publications.