What in the world is a balance sheet?
By George Moriarty • Bankrate.com

Found in any company's quarterly release (10Q statement -- available straight from the company or found on Edgar Online), investors and lenders alike use the balance sheet to get a snapshot of a company's financial picture. Unlike some business concepts, it is painlessly easy to understand. So put aside your innate fear of all things accounting and use the following simple equation: Assets = Liabilities + Equity.

ASSETS represent the company's resources. Both tangible things -- cash, plants, equipment, and real estate -- and the intangibles -- property rights and patents -- are found here. Basically all their money and everything they own.

On the other side of the equation, LIABILITIES, you'll find both short and long-term debts owed by the company. Current liabilities include things such as accounts payable, accrued expenses, and income tax payable. Non-current liabilities include long-term debt and deferred tax liabilities.

EQUITY, the third portion of the equation, includes retained earnings, investment by owners and preferred and common stock.

Assets are listed in the order of how soon they can be turned into cash. Liabilities by how soon they have to be paid. A factor that makes the balance sheet so straightforward is that everything is based on the dollar. There is no room here for the optimistic estimates that so frequently get bandied about during mergers and the like. The balance sheet presents only real cash value, and only for the day noted.

We all learned in grade school that wherever there's an equal sign, the numbers on either side must match. If in your research of a company you find that total assets do not equal total liabilities plus equity, run far and fast. Any company that can't find an accountant to properly balance this sheet doesn't deserve your money and will probably fail before you can snap them off the penny list anyway.

Here's how it works: If I were to add up all the cash in my bank accounts, the value of my investments, the value of all my stuff -- furniture, clothes, stereo, computer, etc. -- plus whatever my friend owes me for dinner last night, you'd get the assets of George Enterprises. Then figure out what I still owe in student loans, the mortgage on my house, and what's left to pay on my car and you get my debts. And finally, the money I can expect to earn from my job over time is my equity. When you add my liabilities to my equity you should get my assets.

The balance sheet is good in that anyone with a calculator and a clue can figure out two important things about a company: liquidity and working capital. Liquidity is determined by looking at current assets to see how readily the company can access cash to pay down its debt. A company with no liquidity runs the risk of missing debt payments and could fall into financial distress -- especially if interest rates rise. You need to make sure that if absolutely necessary, George Enterprises could sell his stereo to make a car payment or cash in one of his stocks to make a loan payment.

Working capital is determined by deciphering which assets and liabilities a company works with on a daily basis. Companies need working capital to cover daily, weekly, and monthly expenses, like payroll, rent, and Post-its. George Enterprises would need enough money in the bank to buy groceries, pay the electric bill, and to cover credit card bills month to month.

While the balance sheet doesn't necessarily tell you where a company's going or where it's been, for a clear, simple picture of where it is today, the balance sheet is critical.

-- Posted: Oct. 25, 2000