FUNDAMENTAL ANALYSIS: HOW TO READ A BALANCE SHEET REPORT?

 Profit and loss accounts give the status of profitability for a year. The cash flow report gives the status of cash flows for a year. But the balance sheet report tells the status of assets, liabilities, equity from the day a company is formed.

Talking about the balance sheet in more colloquial terms, we can say that it tells how a company has handled its finances. Better utilization of finances ultimately leads to more profitability and cash flows.

So we can say that for a company it all starts with its balance sheet. Let’s know more about it.

Simplified Balance Sheet

The above image is a graphical representation of a balance sheet. What a balance sheet balance? It is balancing Assets on one side and equity plus liabilities on the other. That’s the most basic understanding of a balance sheet report that we must remember. It gives us our Balance Sheet Formula. 

From a general perspective, this is what a balance sheet reports tells us about the company.

Liability Side

Source of Fund: On the liability side, what we can find are the sources from where the company is arranging its finances. There are two ways a company can fund its business: (a) through the equity route and (b) through the debt route. A balance sheet report will tell what proportion is equity and how much is from debt. 

Equity: In this type of funding, a company is selling the ownership (shares) of its business in the stock market. People are buying those shares and becoming shareholders. The money so accumulated from the sale of shares is the capital raised through the equity route.

Liability: There are two types of liabilities: Long term and short term. When a company takes a loan for which the payback time is more than 12 months, it is a long term liability. Likewise, loans with payback time shorter than 12 months will be short term liability (also called current liability). The money so accumulated from debt is a liability for the company.

Asset Side

Utilization of funds: On the liability side, what we have seen are the two sources of funds; equity and debt (total capital). On the asset side, we will see how the company uses these funds to run its business. Running a business can be seen as a two-fold process: (a) running the operations, and b) growing the operations.

Non-current Assets: These majorly are constituted by fixed assets. A major portion of the total capital (equity & long-term debt) is used by the company to buy property, plant, and equipment. In other words, this money is used to build the infrastructure of the company.

Current Assets: Another portion of the total capital is used to manage the current & upcoming needs (cash) of the company. What are the current needs? Already booked expenses (current liabilities). What are the upcoming needs? Working capital (non-booked future current liabilities).

Balance Sheet Analysis – How to read a balance sheet?

How to read a balance sheet with ease? First, divide the whole report into five sections. What are these sections? Five sections are: (1) equity, (2) non-current liability, (3) current liability, (4) non-current assets, and (5) current assets.

Let’s start reading the balance sheet items line by line for the best understanding.