Balance sheet, explained
To be a great investor, you’ll need to understand financial statements such as the balance sheet. Here’s an introduction to it. (Note: If you want to grow wealthier through the stock market over time without learning much, you can do very well simply investing in a low-fee index fund, such as one that tracks the S&P 500 index.)
There are three main financial statements that publicly traded companies issue at least quarterly. While the income statement and cash flow statement present how a company performed over a period such as a quarter or year (calendar or fiscal), the balance sheet reflects the company’s financial health at one moment in time — often the end of a quarter or year.
A company’s balance sheet is like what you’d get if you tallied up all your assets (such as house, car, bank accounts and perhaps a wine or art collection) and subtracted your liabilities (mortgage, car loans, credit card debt and others), to arrive at your net worth. It has three main sections: assets, liabilities and shareholder equity. Assets, often on the left, are set equal to — or balancing — liabilities and shareholder equity, often on the right.
Assets may include such items as “cash and cash equivalents,” “investments,” “prepaid expenses” (such as insurance paid for ahead of time), and “property, plant and equipment.” Some other assets, though, are not quite as reliable. “Accounts receivable,” for example, reflects money from sales that the company hasn’t yet received — and may not receive. And “inventory” reflects cash tied up in materials that haven’t been sold yet, some of which may end up not sold.
Liabilities often feature both short-term and longterm debt. Debt is not necessarily bad, although it’s best to see relatively little of it. Another liability, “accounts payable,” represents invoices not yet paid. These can actually be helpful, if the company is delaying payments until they’re due and using the cash in the interim.
Finally, shareholder equity, the difference between assets and liabilities, is the portion of the company that its shareholders can claim.