A balance sheet or general balance sheet is a financial accounting document that companies present on certain occasions (quarterly, semi-annually or annually) where it reflects the economic and financial situation of the company at a certain time. These can help us clearly visualize the situation of a company to be able to predict the future evolution of the company and in turn whether they are correctly managing their shareholders' capital. Let's see how we can interpret these documents and what ratios we can use to analyze them.
What is a balance sheet/general balance sheet?
A balance sheet or general balance sheet is a financial accounting document that companies make reflects the economic situation and assets of it on a specific date. These documents are prepared periodically and allow us know the situation of assets and finances present in a company. A balance sheet consists of three key components:
- The assets of the company.
- The liabilities of the company.
- Shareholders' equity.
Companies should strive to ensure that balance sheet components are maintained in a healthy balance. The assets of a company must always match the sum of the share capital added to the liabilities in value. We can see these documents especially when they are presented quarterly results, which serve as a reference for investors to know if a company's stock enjoys a balance in their balance sheets and in turn determine if it is overvalued, undervalued or the future direction it could take.
How to interpret a balance sheet.
At first we may feel quite overwhelmed when seeing such a large amount of data grouped together in a company's balance sheet documents, but it is easier than it seems. First we must look at the part that tells us the assets that the company owns (assets) and the How have these assets (liabilities) been financed?. In assets we can differentiate between those that are current and those that are non-current, which are differentiated mainly by the period of permanence in possession by the company. If the assets will remain in the company for less than a year (as occurs with the treasury, company stocks or debts in favor) are considered current assets. On the other hand, if they will remain in the company for more than a year (as occurs with long-term investments, machinery or vehicles, buildings...) are considered non-current assets. Next we have the liabilities, that belong to debts of the company with banks, creditors or others. We can differentiate two types as we have seen in the assets; the current liabilities, which correspond to debts maturing in a short period of time (less than one year) or non-current liabilities, which correspond to Debts due over a long period of time. Along with the liabilities we can also see the company net worth, which corresponds to the company's own resources. Net worth arises from the difference between the assets and liabilities of the company.
Components of a business balance sheet document.
By reading a company's balance sheet out of the corner of our eye we can see important data, such as the total value of assetsneighbourhood, value of debts along with their expiration dates, account balances, treasury and share capital…All this data is collected by groups, which are classified according to the liquidity of each one.
Most important ratios for the balance sheet.
In order to measure the balance sheets of a company, there are thousands of ratios and metrics that we can use to measure the financial health of a company. Below we are going to list those that we consider most useful when analyzing a balance sheet/general balance sheet document:
1. Financial leverage.
The financial leverage of a company arises from dividing the total liabilities of the company divided by total assets. This calculation tells us what percentage of assets has been financed with external resources. High financial leverage can be a warning sign, since it can indicate that the company requires a lot of outside capital to function. If the calculation exceeds one, it indicates that the company is over-indebted, which indicates that the company has unviable balance sheets in the future.
2. Total debt.
The debt of a company arises from divide the total liabilities by the net worth of the company, which tells us the relationship between the size of liabilities and equity of the company. It is recommended that the debt level of a company be under 1, which would indicate to us that the total of the company's debts are less than funds of the company, a rare occurrence in companies.
3. General Liquidity.
The general liquidity ratio allows us measure the solvency of a company in a short period of time. This ratio arises from divide current assets by current liabilities of the company, which will allow us to identify How many times can the company cover current liabilities with its current assets?. It is recommended that the level of this ratio always be superior to 1.
4. First Degree Liquidity.
This ratio is similar to the one we discussed in the previous paragraph, but in this case the value of the stocks present in the company is subtracted from current assets. It is popularly known as the acid-test and as in the previous case, it is recommended that the level of this ratio be located by above 1. This ratio is one of the most popular because it allows measure the liquidity of a company quickly and reliablySince does not take into account the value of present stocks in the company. This is because the company's inventory They should be sold first in order to calculate liquidity that they provide.
5. Working capital:
This ratio tells us the present difference between current assets and current liabilities of the company. This allows us to know if with the current assets of the company, that is, what they intend to bill in less than a year, could cover the current liabilities, that is, debts to be covered in less than a year.