In this lesson, we are going to learn how to analyze a balance sheet. Pretend that you are going to apply for a loan to put a swimming pool into your backyard. First, you go to the bank to borrow money and are told that you must first provide a list of your current finances. You then write down everything you have that is of value (your checking and savings account, mutual funds, house, and cars). Next you write down all of your debt (the mortgage, car payments, etc.) and then subtract everything you owe from the value of what you own, and this new number is your net worth. You have just created a balance sheet.
- Assets are things that have value. Your house, car, checking account, and jewelry are all assets. Companies total up the dollar value of everything they own and list it under the asset side of the balance sheet.
- Liabilities are the opposite of assets. These include anything that costs a company money. Liabilities include monthly rent payments, utility bills, the mortgage on the building, corporate credit card debt, and any bonds the company has issued.
- Shareholder equity is the difference between assets and liability; it tells you the “book value”, or what remains for the stockholders after all the debt has been paid.
Every balance sheet must “balance” out . The total value of all assets must be equal to the combined value of the all liabilities and shareholder equity (i.e., if a kool-aid stand had $10 in assets and $3 in liabilities, the shareholder equity would be $7. The assets are $10, the liabilities + shareholder equity = $10 [$3 + $7]).