If you want to know how your company is doing then you DO NOT need to read the Balance Sheet. Instead you should read the Income Statement. The Income Statement measures “performance” during a specific period of time (a month, a year), and that is going to tell you how you are doing.
But if you want to know what you own and what you owe the Balance Sheet will give you the answers.
The Balance Sheet is a picture of the assets (what you own), the liabilities (what you owe) and the equity (the difference between the two or your investment in the business) as of a specific point in time.
So, your original question should be reframed as: Do I really need to know what I own and what I owe? I think you should and here is why:
The numbers in the balance sheet are like X rays of the financial condition of your company. They are used to perform quantitative analysis and assess your company’s liquidity, financial leverage, valuation and more.
Liquidity ratios: Financial ratios that measure your company’s ability to pay both short and long-term obligations. The most popular liquidity ratios are:
The current ratio measures a company’s ability to pay off short-term liabilities with current assets: Current ratio = Current assets / Current liabilities
The acid-test ratio measures a company’s ability to pay off short-term liabilities with quick assets: Acid-test ratio = Current assets – Inventories / Current liabilities
The cash ratio measures a company’s ability to pay off short-term liabilities with cash and cash equivalents: Cash ratio = Cash and Cash equivalents / Current Liabilities
Leverage ratios: Measuring how much debt you carry as compared with how much equity (your own investment and profits) are being utilized to fund your company:
The debt ratio measures the relative amount of a company’s assets that are being financed with debt: Debt ratio = Total liabilities / Total assets
The debt to equity ratio calculates the weight of total debt and financial liabilities against equity: Debt to equity ratio = Total liabilities / Shareholder’s equity
The interest coverage ratio determines how easily a company can pay its interest expenses: Interest coverage ratio = Operating income / Interest expenses
The debt service coverage ratio determines how easily a company can pay its debt obligations: Debt service coverage ratio = Operating income / Total debt service
These are but a few of the financial ratios derived from the company’s financial statements that can tell you where you have been and where are you likely to be in the future … unless corrective action is taken on a timely fashion.
Questions?
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