Getting Started: The Balance Sheet

The company has a superb balance sheet... The balance sheet is solid... The balance sheet remains steady... The balance sheet. When it comes to stock analysis, it's something that's referred to a lot. But why?

Simply put, the balance sheet is one of the most important financial documents you can use to evaluate a company's fundamentals ("Getting Started: Fundamental Analysis"). As one of the principal corporate financial statements, the balance sheet's job is to essentially tell investors where a company stands financially.

The balance sheet consists of two main sections: first, assets (usually presented on the left) and second, liabilities and shareholders' equity (usually presented on the right).

A company's assets consist of anything it owns that has real financial value. The liabilities and shareholders' equity (also known as owners' or stockholders' equity) section represents the ways that those things were paid for. Liabilities are anything that a company owes to someone else; bank loans and bond issues are common examples.

Shareholders' equity consists of the company's stock (the kind you might have in your own portfolio) as well as the income the company holds onto from operations, called retained earnings. Each of these -- liabilities, stock proceeds and retained earnings -- can be used to purchase the assets listed in the other section of the balance sheet.

Assets = Liabilities + Stockholders' Equity

The above accounting equation is what makes the balance sheet balance. It's one of the original concepts in financial accounting: A company's assets are equal to its liabilities plus its stockholders' equity. It makes sense. Think about it: A company can't buy stuff without taking out a loan or selling enough stock to pay for it.

The accounting equation holds true for a business on any scale -- even a kid's lemonade stand. With $10 spent on lemons and sugar and another $5 borrowed from Mom and Dad to paint the stand, a kid's lemonade stand balance sheet might look a little like this:

Assets
Supplies inventory: $10
Property and equipment: $5
Total assets: $15

Liabilities and Stockholders' Equity
Liabilities: $5
Shareholders' equity: $10
Total liabilities and stockholders' equity: $15

Even though the kid spent that $15 on his or her lemonade business, that amount remains on "the books," both in the assets section (since the drink-making supplies are still on hand until the drinks start selling) and the liabilities and stockholders' equity section (money the kid put into the company is his or her equity, and the kid still owes Mom and Dad that $5).