How to Read a Balance Sheet for Stock Market Investing?

The prime objective of why people invest in the stock market is to make profits and increase their earnings. Every investor wants to put his money in sectors or companies that are booming and would probably offer high returns.

The challenge however lies in choosing the right company or sector for investing in. These decisions are made by referring to the financial statements of a company and by studying their growth pattern through various financial statements. Statements like Balance Sheet, Cashflow Statements, P&L accounts, etc. reflect a company’s position in terms of profitability and liquidity.

These statements give an insight about where the company has invested its capital, how much reserve has been created by now, and how much money does the firm needs to run its business daily.

What is a Balance Sheet?

A Balance Sheet is a financial document that tells a company’s worth. The balance sheet lists out information on the company’s assets, liabilities, and owners’ equity. Mostly, balance sheets are prepared quarterly.

A balance sheet is reviewed by business leaders, shareholders, and employees and gives them insights into the company’s financial health. Based on the information provided in the balance sheet, they change their strategies for the company.

Balance Sheet Categories To Consider While Investing in Stock Market

Here are five balance sheet categories that considered while investing:

Assets

Assets are divided into two types i.e. Current assets and Non-current assets. Let’s discuss each one by one-

Current Assets: Currents assets are such items that can be converted into cash easily. Some of the current assets are accounts receivables, Inventory, and Cash.

Non-current Assets:  These are the assets that cannot be converted into cash in short term. Some of the noncurrent assets are land, patent, trademarks, goodwill, intellectual property, etc.

Liabilities

Liability is something that a company owes. Liabilities are financial and legal obligations to pay a particular amount of funds to a debtor. This is the reason liabilities are put on the negative side of a balance sheet. Just like assets, liabilities are also divided into current and noncurrent liabilities.

Current Liabilities: Current liabilities are those which should be paid to the debtor within a year. Some of the current liabilities are payroll expenses, rent payments, utility payments, debt financing, accounts payable, etc.

Noncurrent Liabilities: These liabilities are those which are not due for payment within a year. Some of the noncurrent liabilities are leases, loans, bonds payable, provisions for pensions, deferred tax liabilities, etc.

Owner’s Equity

Owner’s equity or shareholder’s equity is something that belongs to owners of business after liabilities. In simple words, whatever is left after deducting liabilities from assets is owner’s equity. There are two elements of owner’s equity first is the money which owner put into the business and the second is earnings from the business.

Investments

Investments are areas and instruments where a company invests its idle money intending to get higher returns. These investments can be either for the short term like for a year or for the long term which is for 3 to 5 years or beyond. A firm’s investment indicates its inclination in different sectors and is a key component for judging whether the firm is planning to grow or to diversify its business.

Working Capital

Working capital is the capital required by a firm for carrying out its day-to-day operations. It is the net current assets of a company after deducting the net current liabilities that a firm needs to pay. A firm’s liquidity is related to the value of the net current assets held by it. The firm’s working capital should be enough to suffice its operating expenses or else the firm will be required to undergo liquidation. Thus, a firm’s working capital should be enough to cover the firm’s expenses or more than what the firm will require to be on the safe side.

Final Note

It is important for a stock market investor to keenly examine all the above components of the balance sheet before investing in any particular company. Some cautious investors might add other balance sheet components also for analysis to have a better and fair understanding which is appropriate. Though the stock market investments are regulated by SEBI one should always seek the help of an experienced broker for online stock trading.

About Author