International Financial Statement Analysis, 3rd Edition

CHAPTER 5

UNDERSTANDING BALANCE SHEETS

Elaine Henry, CFA

Thomas R. Robinson, CFA

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 non-current assets, and current and non-current liabilities;
• describe different types of assets and liabilities and the measurement bases of each;
• describe the components of shareholders' equity;
• convert balance sheets to common-size balance sheets and interpret 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 issues will facilitate analysis. The balance sheet measurement issues are, of course, closely linked to ...