Getting Started: The Balance Sheet

Also, keep in mind that not everything on the balance sheet is valued the same over time -- some capital assets (such as PPE) depreciate, which means that their values decline as the years progress. Depreciation has nothing to do with how much an asset is actually worth; rather, it is the result of dividing the cost of an asset over its useful life. If a company buys a truck that will last 10 years, then the company wants it to show up on the books 10 years from now at $0.

In addition to PPE, other assets (such as patents and accounts receivable) whose values aren't certain are estimated and adjusted on a regular basis. In the case of accounts receivable, sometimes customers will go broke before the company has a chance to collect from them. Taking estimated "uncollectibles" out of an uncertain asset such as accounts receivable makes the numbers on the balance sheet more reliable for investors.

The Balance Sheet: Liabilities

Liabilities aren't always bad. Just as too many assets can create unfavorable liability ratios, having liabilities is a way for companies to acquire assets they couldn't otherwise afford. There are very few large companies with no debt on their books -- borrowing money, at least in the short term, is a vital part of the business world.

Some common liabilities include accounts payable, bonds payable and mortgages. But just because a company doesn't have a lot of debt on the balance sheet, it doesn't mean that it doesn't have large financial obligations. While companies rarely have incentive to hide assets, hiding liabilities from the public is something that recent events have shown to be much more appealing to the Enrons of the world.

So carefully read the footnotes to a company's financial statements. Items such as false "operating leases," bizarre "maturations of debt" and dubious "related-party transactions" can all provide cover for the unscrupulous treatment of liabilities.

One of the biggest concerns from a liability standpoint is a company's risk of defaulting (not being able to pay off its obligations). Defaulting on debt is a surefire way to drop any company's stock price faster than you can say "liquidation sale." That's why looking at the balance sheet is so essential; keeping an eye on current portions of debt alongside certain items on the balance sheet's close relative, the income statement , can give you valuable insight as to a company's ability to maintain its liabilities.