When someone first starts to take interest in investing, questions arise constantly. The most common one you’ll hear (and that I’ve asked hundreds of times) is “What do you think about this company?”

The most common answer I usually get from cognoscenti is, “Look at their balance sheet.”

Here’s a quick way to analyze a balance sheet in under a minute.

00:60:000 - Find the appropriate date

Balance sheets usually have multiple columns of numbers, which can be overwhelming at first site. If you’re planning to invest, find the most recent column. Sometimes it’s all the way on the left, other times it’s all the way on the right.

00:56:391 - Compare Current Assets and Current Liabilities

This is called the “Quick Ratio”. Does this company have enough cash (and cash equivalents) to pay off their debt that is due within 90 days? It’s a pretty good indicator of their short-term financial stability. A good ratio is usually 2:1 or better. It depends on the industry, too. Sometimes it’s ok for certain companies (like utility companies) to have a bad quick ratio. Why? Click here.

00:49:027 - Compare Total Assets and Total Liabilities

This is another good indicator of a more long-term financial stability. If something were to happen to this company and they were on the the fence about declaring bankruptcy as their only viable option, can they liquidate some assets for cash to save themselves? A good ratio, again, is usually 2:1 (but the more, the better). Also, compare total assets and total liabilities with what happened in the past. Have their total assets increased, or decreased? What about their liabilities?

00:40:391 - What happened to their cash recently?

Compare the changes in cash between periods. Has cash gone up, or has it gone down? If it went down, why? This necessarily isn’t a bad thing if cash decreased a little bit. Be careful if cash decreased a lot. If cash decreases slightly, it could mean that they are simply paying their current liabilities (due within 60 days) then they are collecting their receivables (money owed to them, which could be due in 90 days). They could also renew their rent, or prepay their utilities for the entire year. To find this out, look at the “Prepaid Expense” line under current assets. If this number goes up, chances are they dished out some cash for it. The assets are still there, just not in form of “cash”.

00:28:126 - What is happening to their long-term debt?

Is it increasing? If so, this could mean they are expanding. If it’s decreasing, that means they’re probably paying off an outstanding debt. If you see a huge increase in long-term debt, don’t worry. Check their “Property, Plant & Equipment” line under Long-Term Assets. The huge increase in debt could mean that they just purchased new machinery, which will increase labor productivity and in turn output - which means more money in their pocket.

00:15:578 - Look at Retained Earnings

Compare their retained earnings with prior periods. Retained earnings are exactly what they sound like - earnings that are retained by the company, which increases equity (wealth). The difference between the current period and the most recently prior period tells you the difference in their RE. If it goes up, that’s an increase in wealth when all else is equal. If it goes down, maybe they had a rough quarter and sales dropped off a bit.

00:05:282 - Remember to see what the amounts are denominated in

Usually at the top of the balance sheet, it will say something like “In Millions of USD”, or “In Thousands of USD”. The numbers you see on the balance sheet can be deceiving. Take whatever you see at the top of the balance sheet and multiply it by the amounts you see. For example, if it says “In Millions of USD”, and they have “$1,000″ under “cash”, that means they have $1,000,000,000 in cash.

00:00:001 - Don’t invest yet!

Although the balance sheet is a solid indicator of the financial health of a company, you still have to take into consideration the other financial statements including the Statement of Cash Flows (probably the most important, and complicated one to interpret) and the Income Statement. Also consider the reputation of the company, their competitors, and industry outlook.

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