Reading a balance sheet for everyone - a beginners guide

Reading this sentence is probably as easy as 123 and reading a balance sheet can be just as simple. Though before we get to the end of the story we need to make sure that you have had the balance sheet explained . In terms of skill level the first building block is understanding what a balance sheet is. If you do not know what an tiger looks like you will never be able to find one.

Reading a balance Sheet: Warning One Make sure it is complete

If a CPA issues a set of financial statements that only has a balance sheet and is missing the income statement and statement of cash flows they must state that in their opinion letter. The reason this must be stated is that reading a balance sheet without a statement of cash flows is like a stool missing a leg. If you would not want to sit on a chair with two legs then think twice about reading a balance sheet without the other components of a financial statement.

Reading a balance sheet: Warning 2 Where is it coming from

Just because a balance sheet is in balance does not make it correct. There is a reason that a CPA is hired to give their opinion , it is to give the reader the confidence that what they are reading is correct. Though be warned that there are several levels of opinions that a CPA can offer, those being Audit, Review or Compilation. If you are looking at an investment in a public company it is very likely that you are looking at an audited financial statement. Also realize that the CPA is not giving assurance that no fraud was done.

Reading a balance sheet: Warning Three Profit is not everything

Just because a lot of sales are being made does not mean that a company is successful. By looking at the statement of cash flows you can tell where the cash is going. Assets may be growing on the balance sheet that are not collectible or may be losing value. So when reading the balance sheet make sure to inspect assets based on looking at the prior balance sheet. If you do not have the prior balance sheet the statement of cash flows can give you the relationship of the ending balance to the beginning by tracking changes.

Reading a balance sheet is a skill that will increase the more you do it. So don't expect to become Warren Buffet or Donald Trump in a day. Remember they have been reading a balance sheet for quite some time to become such astute investors.