Analyzing Balance Sheets

The balance sheet discloses what an entity owns (assets), what an entity owes (liabilities), and the owners’ interest in the net assets of a company (equity) at a specific point in time. While many balance sheet items are reported at historical cost, some items are measured differently, such as at fair value, and some events and transactions—perhaps contrary to analyst’s expectations—are not recognized at all. Analysts must be familiar with the different rules and practices for recognition, measurement, and disclosure of balance sheet items to evaluate the liquidity, solvency, and overall financial position of companies. To do so, analysts often compute ratios involving the balance sheet and other financial statements, such as the ratio of debt to operating income or cash flows, which can be compared to other companies and over time.