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What is a Balance Sheet? – “How to Price a Stock”

Welcome to part 1 of our series in How to Price a Stock. 

If you’re here, it likely means you’re interested in learning not only more about investing, but companies in general and how to find their true value.

One of the first financial statements we look at in trying to price a stock is the balance sheet. The balance sheet generally gives us the financial strength of a company at any given point in time. The balance sheet works as a “financial snapshot” of a company.

From the balance sheet, we can see three important things: the Assets that it owns, the Liabilities that it owes, and the difference between these two numbers, the Equity. The Equity in this situation works much like the equity you have in your home. 

As you pay down your debt, the equity you have in your own will generally increase because your equity is the difference between the fair market value of the house (your asset) and the amount still owed on the house (your liability). Looking at a balance sheet, it works much the same way. 

There are two ways to increase the equity of a company, increase its assets, or pay down its debts. Looking at which of these options a company chooses, gives us insight into its management, operational capabilities, and its general ability to be strategic or profitable.

If a company can pay down debt at the same time it increases the value of its assets, it generally is in a more strategic position than companies handling their situation by only doing one or the other.

A balance sheet will generally be set up as follows:

Balance Sheet
as of December 31, 2019
Assets
Cash $1,000.00
Accounts Receivable $2,000.00
Inventory $5,000.00
Equipment $10,000.00
Total Assets $18,000.00
Liabilities
Accounts Payable $2,000.00
Loan Payable $5,000.00
Bonds Payable $5,000.00
Owner’s Equity
Stockholder’s Equity $6,000.00
Total Liabilities and Owner’s Equity $18,000.00

 

Note that the Assets balance to the total of the Liabilities and Owner’s Equity. Hence, the term Balance Sheet. 

Grasping the concept of a balance sheet is one of the first and most crucial concepts on the path to being able to do any kind of financial analysis and understanding a company’s capital structure (where it gets its financing from).

From here, we will be looking at what to do with the information from the Balance Sheet and why we should even care about it.

 


This article does not constitute financial or legal advice. For help regarding your specific situation, please consult a local advisor.