Use the right balance sheet equation to evaluate company data
Data obtained from an accounting balance sheet of a company is useful for learning about the company’s financial situation. Lenders and investors are interested in knowing a companies:
- Liquidity – Indicates a company’s ability to repay debt. Common methods used to get liquidity ratios are the current ratio and the quick ratio.
- Financial strength – Assessing how a company is financing growth. Companies can get capital by either borrowing (debt) or through shareholder investments (equity). Debt to equity ratios are a good means of determining financial strength.
- Efficiency – How well the company is returning profit for the capital invested. This requires information from the income statement as well as the balance sheet.
Using the right balance sheet equation can provide the information that investors and lenders need. If you need a balance sheet analysis example, feel free to get in touch.
Useful balance sheet equations
The following are some equations that can be used to determine the liquidity and financial strength of a company using data from an accounting balance sheet:
- Liquidity – Liquidity ratios can be obtained using the current ratio and the quick ratio. The higher the ratios, the better the position of the company.
- Current Ratio = Current Assets / Current Liabilities
- Quick Ratio = (Current Assets – Inventories) / Current Liabilities
- Financial strength – The higher the debt to equity ratio, the more that a company has incurred debt to finance growth. Some debt to equity rations that measure financial strength are:
- Total Debt/Equity Ratio = Total Liabilities / Shareholders Equity
- Long Term Debt/Equity Ratio = Long Term Debt / Shareholders Equity
- Short Term Debt/Equity Ratio = Short Term Debt / Shareholders Equity
Although not entirely a balance sheet equation as it requires data from the income statement some formulas that measure efficiency include:
- Return on Assets = Net Income/Total Assets
- Return on Equity = Net Income/ Shareholder Equity
Total assets and shareholder equity come from the balance sheet. If you are unsure of which balance sheet equation that will work best our company analysis service can help.
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