The Main Focus Points When Analyzing a Balance Sheet - Deepstash

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Why Balance Sheets Are Important to Analysis

A company's balance sheet provides a tremendous amount of insight into its solvency and business dealings. A balance sheet consists of three primary sections: assets, liabilities, and equity.

Depending on what an analyst or investor is trying to glean, different parts of a balance sheet will provide a different insight. That being said, some of the most important areas to pay attention to are cash, accounts receivables, marketable securities, and short-term and long-term debt obligations.

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The Three Categories

Many experts consider the top line, or cash, the most important item on a company's balance sheet. Other critical items include accounts receivable, short-term investments, property, plant, and equipment, and major liability items.

The big three categories on any balance sheet are assets, liabilities, and equity.

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Important Assets

All assets should be divided into current and noncurrent assets. An asset is considered current if it can reasonably be converted into cash within one year. Cash, inventories, and net receivables are all important current assets because they offer flexibility and solvency.

Cash is the headliner. Companies that generate a lot of cash are often doing a good job satisfying customers and getting paid. While too much cash can be worrisome, too little can raise a lot of red flags.

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Important Liabilities

Like assets, liabilities are either current or noncurrent. Current liabilities are obligations due within a year.

Fundamental investors look for companies with fewer liabilities than assets, particularly when compared against cash flow. Companies that owe more money than they bring in are usually in trouble.

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Kinds Of Liabilities

Common liabilities include accounts payable, deferred income, long-term debt, and customer deposits if the business is large enough.

Although assets are usually tangible and immediate, liabilities are usually considered equally as important, as debts and other types of liabilities must be settled before booking a profit.

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Important Equity

Equity is equal to assets minus liabilities, and it represents how much the company's shareholders actually have a claim to. Investors should pay particular attention to retained earnings and paid-in capital under the equity section.

Paid-in capital represents the initial investment amount paid by shareholders for their ownership interest. Compare this to additional paid-in capital to show the equity premium investors paid above par value. Equity considerations are among the top concerns when institutional investors and private funding groups consider a business purchase or merger.

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