Our friend the balance sheet is essentially a snapshot of a company's financial condition at a single point in time (often the end of a fiscal quarter). This is different from several other statements, which reflect how a company did over a period of time. Balance sheets focus on just one moment.
For your own personal balance sheet, you'd list all your assets, subtract your debts and obligations, and end up with your net worth. Companies essentially do the same thing, and Fools can gain valuable insights into a firm's financial strength by studying this document.
The balance sheet has three main parts: assets, liabilities, and shareholder equity. Assets are set equal to -- or in balance with -- liabilities and shareholder equity. The funny thing is, though, some assets can be bad and some liabilities can be good. Here's why.
Take a gander at assets. In this category, you'll find items such as "cash and cash equivalents" and "short-term investments." That's how much unused gunpowder the company has. These assets are good, but most other assets are not as good. Consider "accounts receivable." That's money from sales the company hasn't yet received and can't use. "Inventory" reports how much product is in various stages of preparation. It's cash tied up in materials that haven't yet been sold. Not so good.
Other balance sheet assets may include investments, "prepaid expenses" (such as insurance that's paid ahead of time), and "property, plant, and equipment" (PP&E).
Liabilities are likely to include short-term (also called "current") debt and long-term debt. Debt is not necessarily a bad thing, although we generally don't like to see much long-term debt. In a sense, debt can be considered an asset, as it often represents cash that the company is putting to work.
"Accounts payable," essentially short-term debt, represents invoices not yet paid. These can also be good. They may reflect a company delaying payment until it's due and using the money in the interim.
Finally, shareholder equity is the portion of the company that stockholders can claim. Simply put, it's the difference between assets and liabilities. By studying a balance sheet, you can evaluate a company's current condition and also see whether its financial health is improving or failing.
You can learn more about how to interpret financial statements in our "Crack the Code: Read Financial Statements Like a Pro" How-to Guide (essentially a self-paced online seminar). Give our How-to Guides a whirl. More than 90% of those who've taken them have consistently given them high marks -- and besides, we offer a satisfaction guarantee, or your money back. What do you have to lose, except your fear of financial statements?