The balance sheet

The income statement covers a stretch of time. The balance sheet is a photograph taken on one day — usually the last day of the quarter — showing the financial position at that instant.

The equation it is built on

Assets equal liabilities plus shareholders' equity. That is not a discovery; it is a definition. Everything the company owns was paid for either with borrowed money or with owners' money, so the two sides match by construction.

• Assets. Cash, money owed by customers, inventory, buildings, equipment, and intangible items such as acquired brands.
• Liabilities. Money owed to suppliers, debt, tax owed, and obligations due in future periods.
• Shareholders' equity. The residual. What would remain for owners if every asset fetched its stated value and every debt were paid.

What to look at first

1. Cash against debt. Not debt alone. A company with large borrowings and larger cash reserves is in a different position from one with the same debt and none.
2. Working capital. Short-term assets minus short-term liabilities. It tells you whether near-term bills can be met from near-term resources.
3. Goodwill. An intangible created when a company pays more for an acquisition than the assets were worth. Large goodwill is a record of past optimism, and it can be written off suddenly.
4. The direction of travel. Compare with a year ago. A balance sheet improving or deteriorating tells you more than its absolute state.

The limitation worth remembering

A balance sheet is dated. It describes one day, and a company with seasonal patterns can look materially different at two different quarter ends without anything meaningful having changed.