New to investing? How to check a company’s balance sheet

Michael Taylor looks at how to assess a company’s balance sheet and how it can help you make investment decisions.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

One of the most important financial statements for investors to understand is the balance sheet. This records the state of the company at a single point in time. It can be manipulated to a certain extent, but by checking the balance sheet each year, we can see how the financial health of a company is changing and whether that company’s stock is a worthy recipient of our hard-earned investment cash. 

The accounting equation

Most people will be familiar with the accounting equation, but if not here it is: Assets – Liabilities = Equity

Equity, or shareholder equity, is what is left over once the liability holders have taken their share. If the company were to go bust tomorrow, then the liability holders would have first claims on the assets, with any leftovers going to the equity holders. 

The accounting equation is important because it is the assets of a business that are important. Clearly, the assets have to be of a high enough quality to generate value for the business, and ultimately its owners, we shareholders. 

Check the company’s assets year-on-year

By looking at how the financial health of a business changes every year we can see how healthy the business is and this will help us decide whether we should hold on to our shares or potentially take the plunge with a firm. If cash has increased substantially, then it’s worth checking out the cause of that consequence. 

Was it because the business was cash generative? We can check the operational cash flow statement here? Or was it because the company sold a lot of equity for cash and diluted shareholders? We can check the financing cash flow statement here. 

How have the company’s tangible assets changed? It is worth checking management’s policy on depreciation here, and again for amortisation when checking the company’s intangible assets. 

Check current and non-current liabilities

The company’s liabilities are very important. This is because if the liability holders become too nervous, they can call in their loans. If the company is not in a financially stable enough position to pay these off and survive, then the business cannot continue.

Check the company’s current debt — debt that is to be paid in the next 12 months. This can be trade payables or administration expenses.

Also check also the company’s non-current debt — debt that does not need repaying in the next 12 months. This can be bank debt, or loans from shareholders or other directors. 

One thing to be aware of too is if the directors are lending money to the company and whether they are then incentivised to see the business collapse so they can pick it up cheaply. This is a very real risk with some firms and something of which to be aware.

The balance sheet and other financial documents 

The company’s health is carefully laid out in the balance sheet, and for any serious investor it is important to check this alongside cash flow statements in order to make proper sense of the business.

Look at how much the company is burning through per period, and check the company’s cash balances. This will ensure that we are not buying shares in a business that will be launching a dilutive equity placing not long after we buy. Happy investing!

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Views expressed in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

Are these the best stocks to buy on the FTSE right now?

With the UK stock market on the way to hitting new highs, this Fool is considering which are the best…

Read more »

Petrochemical engineer working at night with digital tablet inside oil and gas refinery plant
Investing Articles

Can the Centrica dividend keep on growing?

Christopher Ruane considers some positive factors that might see continued growth in the Centrica dividend -- as well as some…

Read more »

Smiling family of four enjoying breakfast at sunrise while camping
Investing Articles

How I’d turn my £12,000 of savings into passive income of £1,275 a month

This Fool is considering a strategy that he believes can help him achieve a stable passive income stream with a…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

2 top FTSE 250 investment trusts trading at attractive discounts!

This pair of discounted FTSE 250 trusts appear to be on sale right now. Here's why I'd scoop up their…

Read more »

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.
Investing Articles

3 things that could push the Lloyds share price to 60p and beyond

The Lloyds share price has broken through 50p. Next step 60p? And then what? Here are some thoughts on what…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

£1,000 in Rolls-Royce shares a year ago would be worth this much now

Rolls-Royce shares have posted one of the best stock market gains of the past 12 months. But what might the…

Read more »

Investing Articles

Are HSBC shares a FTSE bargain? Here’s what the charts say!

There are plenty of dirt-cheap FTSE 100 banking stocks for investors to choose from today. Our writer Royston Wild believes…

Read more »

Three signposts pointing in different directions, with 'Buy' 'Sell' and 'Hold' on
Investing Articles

Just released: Share Advisor’s latest ‘Hold’ recommendation [PREMIUM PICKS]

In our Share Advisor newsletter service, we provide buy, sell, and hold guidance for our universe of recommendations.

Read more »