Along with a company's income and cash flow statements, the balance sheet is one of the basic financial documents. The income statement tells you how much the company made in a given period. The cash-flow statement shows whether it has money to pay its bills. The balance sheet shows how much of the company's worth is eaten up by debt and how much truly belongs to the shareholders.
When you look at a balance sheet, you're looking at an equation. On one side, you have the company's total assets: cash in the bank account, inventory on store shelves, company vehicles, computers and factories, plus nonphysical assets such as patents and trademarks. On the other side of the equation you have the company's total liabilities and shareholders' equity -- the value of the shareholders' total stake in the company.
Liabilities -- debts the company owes -- fall into two categories: current and noncurrent. Current liabilities include bills the company hasn't paid yet and short-term debts -- loans coming due in the next year. Short-term debt is an important item: it's very bad news if the company doesn't have the money available to pay it all off. When reading the balance sheet, compare current liabilities to current assets, which represent cash and assets that can be sold fast. Ideally, the current assets are double the current liabilities.
Shareholders' equity -- AKA net worth, net assets or capital -- is what's left after you subtract total liabilities from total assets. The ratio of debt to equity can tell you whether a company is financially sound or dangerously over-leveraged through excess borrowing. The retained earnings section of equity shows you the company's total cumulative profit since it launched, less dividends paid out to shareholders. Treasury stock is a line item showing the value of shares the company has bought back from shareholders.
To gain more information about a company, look at three years of balance sheets, not one. If the company's been reducing its debt burden -- or adding to it -- comparing the year-to-year liabilities will show you so. If "accounts receivable" on the assets side keeps growing, that might indicate the company's not able to collect on what it's owed. What constitutes a healthy balance sheet varies among industries: Banks rely on debt financing, for example, but service firms usually use lots of equity.
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.