A balance sheet shows every thing a company holds at a particular point of time – assets and liabilities.

All the publicly traded companies in Bhutan must publish financial report every year end.

A complete financial report must have all three parts; income statement, balance sheet, and cash flow statement.

I published post on how to understand and use the income statement for deciding in which company to invest.

Similarly, in this article I like to share how you can interpret and then use the balance sheet.

I hope it will be helpful when you do your technical and the fundamental analysis to invest in a stock market.

Balance Sheet — Meaning + Purposes

Balance sheet is also called as a statement of financial positions. There are two main types of balance sheet.

In a vertical balance sheet, asset items are on the left and liabilities right listed under categories. But in other, listing is horizontal.

In Bhutan, almost all the companies use the horizontal version. It’s good for showing projections and comparisons.

However, overall rationales and objectives of a balance sheet remain all the same.

Balance Sheet — How to Read it Well

If we divide main sections further, we get current and non-current assets, non-current and current liabilities, and then shareholders’ equity.

Assets: The resources that a company owns for future economic returns are its assets.

Current Assets: Assets that can be converted into cash or be used within one year.

• Cash and Cash Equivalents
• Accounts Receivable
• Inventory/Stock-held-for sale
• Prepaid Expenses
• Short-term Investments

• Property, Plant, and Equipment (PP&E)
• Intangible Assets (like Goodwill)
• Investments in Other Companies
• Long-term Investments (like bank FD)

Current Liabilities: All the debts and obligations which the company must settle within one year.

• Accounts Payable/Sundry Creditors
• Short-term Debt
• Accrued Liabilities
• Current Portion of Long-term Debt

• Long-term Debt
• Deferred Tax
• Pension Liabilities

Shareholders’ Equity: The residual interest in the company’s assets after deducting liabilities.

• Common Stock/Shares
• Retained Earnings

Shareholders will get it if the company closes down. Since shareholders and company aren’t one and the same, it’s under liabilities.

Balance Sheet — Drawing Sense of it

It is important to review individual items or group of items in the balance sheet to draw investing senses.

In the assets section, you look at the cash and cash equivalent balances. They are signs of financial strength.

Usually companies with more cash can seize business opportunities and ride through rough business cycles.

High level of accounts receivables, and stock shows a healthy cash flow. But be concerned if they are excessive.

In non-current assets, I look for changes in PPE. The increase is business growth and expansion plans.

You also check sundry creditors or short-term debts. The company must have enough cash to settle them.

Will you invest in a company having so much loans? So, review long-term debts, and their interest rates as well.

I check no of outstanding shares and retained earnings. Positive retained earnings with less no. of outstanding shares is good.

How to Check the Financial Health

We can calculate few main financial ratios to examine the financial health of a company. Some of them are:

Current Ratio: Divide current assets by current liabilities. It checks how a company can meet short-term liabilities. It should be above 1.

Debt-to-Equity Ratio: To check if the company is borrowing more than its shareholders invest. Low ratio shows low financial leverage.

Return on Equity: Checks profitability for shareholders. It is calculated by dividing net income by shareholders’ equity.

There are many ratios you can use based on your needs. You can use the EPS to calculate P/E ratio as well.

Some investors also use historical trends, industry peers, and also views of professionals to avoid ending up investing in monkey business.

Investing involves risks. We need to do comprehensive research. Reading and analyzing balance sheet can be a part of such research.

How do you use the balance sheet before investing in that company? Do you also look other indicators? 

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