Before finalizing a decision on which company to invest your hard-earned money in, it is recommended that you understand the balance sheet properly so as to analyze its important elements. It is through such analyzing that right investment decisions are made most of the time.
You must understand that just because some points are more than others, it does not mean that the rest of the points are useless. Rather, every point has its own significance that contributes to the overall result of the balance sheet. With this in mind, we can move on to the first step which is examining the trends alongside the current. These include the trends related to profit, overheads, assets, margins and so on.
Since the balance sheet lets us see a still image of the ever-changing finances of a particular company, we must always remember to take into consideration the market conditions of that period while analyzing the balance sheet. Previous balance sheets should also be brought forward for analyzing as a trend can be calculated whereupon current business decisions can be made.
Another thing that we should do is compare the particular company to other companies in the same industry. This way we can determine where our company stands in the market. Of course, there are some key points that you need to remember –
- Whether the liabilities of the company can be paid off with liquid cash.
- Whether the total amount of assets is greater than the total amount of debts.
- Do the creditors owe enough money to be able to run the business smoothly?
- Are sales coming in from the optimal use of the company’s assets?
- How much profit is generated from these sales?
- Out of the total equity of the business, exactly how much belongs to shareholders?
- A fixed figure in terms of capital that will be enough to make sales and finance the business throughout the envisioned period.
- How much improvements has the company made financially since it was first established?
Since most of these answers require a comparison to external data, you can see why it is important that additional information regarding the surrounding factors of the business needs to be gathered.
A quick glance at the balance sheet will show you things such as ratio of debt/equity, amount of cash and equivalents and the assets along with their depreciation rate. These are crucial in that they are directly affected by how much you are looking to invest. The low debt to equity ratio will appeal to a value investor who wants a low book value when compared to the price of shares, whereas the conclusion of maximum leverage with minimal cash may lure in a willing growth investor.
Not only that, but we should also look at other financial statements. The reason for this is that these statements will help us see where the capital of the company was spent, thereby helping us make adjustments in required areas to keep maximizing profit for the projected period of time. For instance, the Profit and Loss Statement shows us the sales and their cost, profits and expenses.
Some of the things reflected in the balance sheet are quick ratio, current ratio, ratio of debt to equity etc.
You must also know how liquid the assets are – the more positive the figure, the better the financial standing of the business. Finally, the executive team should be inspected closely as these are the ones that are piloting the business and their actions, no matter how small, can often have a huge impact in the earnings of the company,