Can reading a balance sheet work like reading a good book?
Forget what you might know about financial statements for a moment. Consider instead what a business, any business is really trying to do and never lose sight of it: make a profit.
On any day of the week, whether it is a start-up or a Fortune 500 establishment, every business has a range of goods and services for sale. Every business uses its financial resources to acquire raw materials to generate finished goods and services in hopes of selling these same products in the market place for more than it costs to produce them. If management succeeds in making profits, the business will prosper. If it does not, it will go bankrupt.
The story of where the business stands appears on the balance sheet.
Regardless of the type of firm, all businesses report their activities using a balance sheet (along with other key statements.) In other words, balance sheets help companies tell their story to the world.
Today, bankers, trade creditors and investors rely heavily on detailed financial statements like balance sheets to gauge the financial health of any investment opportunity.
This record of the company’s financial structure shows:
- What the company owns (assets).
- What it owes (liabilities).
- What is left over for the owners (shareholders) after what it owes is deducted from what it owns (the net worth, also called equity).
A balance sheet offers a static picture, or snapshot, of the company’s financial structure on the day it was compiled. That means it can vary from day to day.
These statements can be useful to us as traders as we try to form an image of the company’s basic financial structure and level of indebtedness at particular points in time.