How to read a balance sheet
Balance sheets are one of the main financial statements that investors use to assess a company. You can easily access a public company’s balance sheet through a website like Yahoo! Finance, but before you do you may want to arm yourself with this simple tutorial on how to read a balance sheet.
The three types of balance sheet accounts are assets, liabilities, and equity.
- Assets show what a company has. Under assets on the balance sheet, you will find items such as cash, inventory, and equipment.
- Liabilities show how much the firm in question owes to other people.
- Equity, in contrast to liabilities, is how much the firm owns.
Assets must always balance with liabilities and equity, hence the name balance sheet. The items that the firm has (assets) must either be owed or owned, so assets always equal liabilities plus equity. This relationship is called the Accounting Equation, and is the basis of double-entry accounting.
How to Make a Balance Sheet
Read on to see a simple example that will help you learn how to read a balance sheet by seeing how to create one.
Ernie has decided to start a small business raising dairy goats. He names the business E-Dairy and invests $10,000 into the business.
On the balance sheet: $10,000 is now E-Dairy’s asset. It can be used to buy things, and make money. The $10,000 is also recorded under equity because E-Dairy does not owe any of it to anyone.
Assets = $10,000
Liabilities = $0, Equity = $10,000
Next, Ernie decides to build a barn. A local construction company tells him it’ll cost $20,000. Since he doesn’t have much cash, Ernie gets a bank loan for $20,000, pays the builder, and gets his barn.
The barn is now listed as an asset worth $20,000. Because the money used to pay for it is a loan from the bank, Ernie must also list a $20,000 liability on the balance sheet.
Assets = $30,000
Liabilities = $20,000, Equity = $10,000
Finally, Ernie decides to buy his first goat for $3,000. The goat is an asset because Ernie will use it to make money. However, cash must decrease. In this case, all of the changes to the balance sheet will be among the assets, so liabilities and equity won’t change.
Assets = $30,000
Liabilities = $20,000, Equity = $10,000
Now you know the basics of how to read a balance sheet! Now you can try to read this balance sheet from Google’s financial statements. Don’t worry if a lot of it doesn’t make sense- now you know the basics of the three categories, and you can tell how much of Google’s assets are owed to other people, or owned by Google’s shareholders.
Photo of Cash: sxc.hu/isouthpawi
Photo of Barn: sxc.hu/drouu
Photo of Goat: sxc.hu/cegie
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