What is a balance sheet?
Source: Digital Juice
A balance sheet is a financial statement that lists all your assets and liabilities—what you own and what you owe. It’s a fundamental part of finance. It’s an accounting ledger that lists, on one side, what you are doing with your money, and on the other side, where the money came from. It’s a snapshot at a point in time. Everyone and everything that deals with money has a balance sheet: families, businesses, governments—even central banks.
There’s the list of assets or liabilities, and there’s also the value put on them. For simple things—cash, homes, offices—the value is fairly easy to determine. But for complicated items—raw land, education, a corporate brand or logo—the value is more fuzzy. Still, the notion that assets and liabilities always balance—with the difference being net worth—is important.
Source: Positive Money
People get mixed up is when they rigidly import principles from one sphere into the other. For example, in personal finance it’s good to avoid debt, especially for depreciating assets. After all, that money needs to be paid back, and those debts can tie you down. But in corporate finance, it can be irresponsible to avoid debt. A firm that finances a mature business with just equity isn’t serving its shareholders well. By its nature, equity costs more than debt. An asset with stable but modest cash-flows may still be a worthwhile investment if it’s funded by an inexpensive loan from a secure lender.
Balance sheets matter. They determine how diversified a company’s finances are, and how flexible they can be in the future. They can also clue us in to some of the games people play with their bookkeeping. Learning how to interpret a balance sheet is as useful as learning how to read literature, or reading the clouds in order to understand the weather.
Investing is like sports—endless preparation followed by intense competition. And understanding financial statements is like running—a fundamental skill that we need in order to win.
Douglas R. Tengdin, CFA
Chief Investment Officer
Leave a comment if you have any questions—I read them all!