## 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 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. If the ratios are high enough, the position of the company will improve continuously.

*Current Ratio = Current Assets / Current Liabilities*

*Quick Ratio = (Current Assets are 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 ratios 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.

## Learn by Example

The best way to learn how to calculate a balance sheet equation correctly is to follow a step-by-step solution that actually explains why each stage takes place. Only then can you understand the entire process and truly appreciate the financial position of the company in question.

- All calculations start with a definition of the components within. The basic accounting calculation for any balance sheet includes three distinct parts:

*Assets = Liabilities + Owner’s Equity*

- The extended accounting calculation that allows you to work out the balance more accurately merely includes some of the factors which inform the account owner’s equity. These factors will increase or decrease the owner’s equity and thus allow you to calculate the true value of their assets.
- Examples of factors which affect the account owner’s equity include revenue, which increases equity and expenses and dividends, which decrease equity.
- Ultimately, if revenue is greater than expenses, you can expect the company to be making a profit unless there are some rather bizarre circumstances that subsequently occur.
- Here is the extended accounting calculation in full with numbers attached to a moderately successful company.

*Assets = (Liabilities + Equity + Revenue) – (Expenses) – (Dividends/Draws)*

*$100,000 = ($20,000 + $40,000 + $80,000) – ($20,000) – ($20,000)*

- Always make sure that the two sides of the equation balance. Otherwise, something has gone wrong and your sums won’t be accurate.

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