Our friend the balance sheet is essentially a snapshot of a company's financial condition at a single point (often the end of a fiscal quarter). This is different from several other statements, which reflect how a company did over a longer 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 company's financial strength by studying this document.
The balance sheet is made up of 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 a company's amount of unused gunpowder, which can be spent on acquisitions or other ways to grow the business. (Microsoft (NASDAQ:MSFT) has around $40 billion in cash and marketable securities on hand, while Wal-Mart (NYSE:WMT), a bigger company, has about $6 billion.)
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. Note that companies with "light" business models, such as eBay (NASDAQ:EBAY) and Google (NASDAQ:GOOG), hold little to no inventory. That can be an edge.
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, since it often represents cash that the company is putting to work. Compare debt to cash to get a general impression of the company's condition. Lucent (NYSE:LU), for example, recently had about $2 billion in cash and marketable securities and more than $4 billion in long-term debt. That's not ideal.
"Accounts payable," essentially short-term debt, represents invoices not yet paid. These can also be a good thing. 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. Read our "Understanding the Balance Sheet" article for more insight into how to make sense of this financial statement.
To learn more about how to make sense of financial statements in general, check out our "Crack the Code: Read Financial Statements Like a Pro" how-to guide (also known as an online seminar). Give any of ourhow-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. If you're not satisfied, you get your money back.
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Microsoft is a Motley Fool Inside Value recommendation, and eBay is a Motley Fool Stock Advisor pick.
