Analyzing the Balance Sheet | Financial Statement Analysis

The balance sheet (aka the statement of financial position) tells you (a) what the company's assets are and (b) how those assets are financed (by liabilities or equity).

The balance sheet is used to:
(1) assess creditworthiness (it tells you about a company's short-term liquidity and long-term solvency)
(2) calculate rates of return (in conjunction with net income from the income statement)

The balance sheet has several shortcomings, however:
(a) some assets are not recorded on the balance sheet (e.g., Coca-Cola's brand value)
(b) some assets are understated on the balance sheet (e.g., a Coca-Cola trademark would appear on the balance sheet at its historical cost, not its fair market value)
(c) companies may structure transactions to keep certain items off the balance sheet (e.g., keeping the debt of a joint venture off the balance sheet to appear less leveraged)

The balance sheet can be further analyzed using:
(1) ratio analysis (e.g., the current and quick ratios tell you about short-term liquidity, while the debt to equity ratio and debt ratio tell you about long-term solvency)
(2) common-size balance sheet (each line item is expressed as a percentage of total assets, which gives you an idea of each item's significance)
(3) percentage change balance sheet (this identifies significant changes in balance sheet items over time, such as a spike in receivables)
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