CHAPTER 5
UNDERSTANDING BALANCE SHEETS
LEARNING OUTCOMES
After completing this chapter, you will be able to do the following:
- Describe the elements of the balance sheet: assets, liabilities, and equity.
- Describe uses and limitations of the balance sheet in financial analysis.
- Describe alternative formats of balance sheet presentation.
- Distinguish between current and noncurrent assets, and current and noncurrent liabilities.
- Describe different types of assets and liabilities and the measurement bases of each.
- Describe the components of shareholders’ equity.
- Analyze balance sheets and statements of changes in equity.
- Convert balance sheets to common-size balance sheets and interpret the common-size balance sheets.
- Calculate and interpret liquidity and solvency ratios.
1. INTRODUCTION
The balance sheet provides information on a company’s resources (assets) and its sources of capital (equity and liabilities/debt). This information helps an analyst assess a company’s ability to pay for its near-term operating needs, meet future debt obligations, and make distributions to owners. The basic equation underlying the balance sheet is Assets=Liabilities+Equity.
Analysts should be aware that different items of assets and liabilities may be measured differently. For example, some items are measured at historical cost or a variation thereof and others at fair value.1 An understanding of the measurement ...
