How to Read Balance Sheets Like CFO (2024)

Understanding a company’s balance sheet is a must when it comes to smart investing. A strong balance sheet can be the difference between a prosperous investment and a financial disaster. When a company is drowning in debt or struggling with dwindling cash reserves, it’s like a red warning flag waving, and it could mean your investment is in jeopardy.

Now that we’ve delved into the income statement, let’s transition to the balance sheet. The underlying concept is that the income statement reveals how much money the company has made in a year. In contrast, the balance sheet is to assess how wealthy the company is or how much money it has generated throughout its existence. In this example, we are going to be using Apple.

The Financial Equation: Assets = Liabilities + Shareholders’ Equity

A balance sheet has three sections: assets, liabilities, and shareholders’ equity.

1. 💰 Assets: an asset is any item or resource with monetary value that a business owns, cash that the company has in its bank account or the factory where the company manufactures its products would both be examples of assets, and more.
2. 📄 Liabilities: a liability is something that the company owes. Things such as a loan from a bank or payment that the company owes to one of its suppliers, and more.
3. 🤝 Shareholders’ Equity: This reflects the investment made by the company’s owners.

Both the asset section and the liability section are further broken up into two subcategories: current and non-current. Assets are the company’s power, and they come in two:

1. Current Assets: these are assets that can be turned into cash within a year, like: cash, short-term investments, accounts receivable, and inventory.
2. Non-Current Assets: these are longer-term assets with a full value that you cannot recognize until after one year, like: property, machinery, goodwill, and patents.

It’s also interesting to note that assets appear in the order of their liquidity, with the most liquid assets at the top and the least liquid assets at the bottom of the asset section. Here’s the scoop from most to least liquid:
Cash and equivalents
Marketable securities
Financial assets
Inventories
Investment property
Plant and equipment
Intangible assets
Goodwill
Other current assets

Liabilities are the company’s financial responsibilities, and they’re split into two:

1. Short-Term Liabilities: these are debts that need to be paid off within a year, like: short-term loans and bills to be paid.
2. Long-Term Liabilities: these are debts that have due dates further in the future, like: long-term loans and pension obligations.

Just like assets, liabilities are also lined up by how quickly they need to be settled. Here’s the scoop from most to least liquid:
Accounts payable
Notes payable
Accrued liabilities
Unearned revenue
Long-term financial liabilities
Deferred tax liabilities

Shareholders’ equity is like the treasure chest, showing the money invested by the shareholders. It typically falls into three categories:

1. Contributed Capital: The money shareholders invested when they bought their shares.
2. Retained Earnings: The profits the company kept for reinvesting in the business.
3. Treasury Stock: The cash the company spent to buy back its own shares.

Understanding these financial building blocks is your key to making smart investment decisions.