Revealed: What you can learn about a company from its balance sheet

Fsp Invest, 26 Nov. 2013

Tags: balance sheet, what is the balance sheet, gearing, annual report, annual statements, financial report, investing, fundamental analysis

When you’re researching companies to invest in, one thing that you must take a closer look at are annual reports. That’s where you’ll find the balance sheet, along with the rest of a company’s financial results. All companies with a listing on the Johannesburg Stock Exchange publish these at least twice a year. Read on to uncover what you can learn about a company from its balance sheet…

In a company’s financial report, you will come across the balance sheet, the research team at Red Hot Penny Shares explains…

The balance sheet is a statement which shows at the period end:
  • What the company owns (its assets); and
  • What the company owes (its liabilities).
Because the balance sheet shows you this information at the end of a reporting period, it can be slightly misleading.

For instance, at the end of December, a retailer should have lower borrowings and more cash than at the end of November. That’s because it’s just completed its busiest trading period of the year.

In the period before the festive season, most retailers would have high borrowings to support high stock levels, but little cash.

For this reason, many retailers have their financial year-end at the end of December year. This makes their balance sheets look as healthy as possible in the annual report.

The balance sheet can indicate how financially sound a company is

Analysts use the balance sheet as an indication of the financial strength of a company.

The most commonly quoted balance sheet ratio is gearing. This is a company’s total debt (long- and short-term loans, and bank overdrafts, but less cash) expressed as a percentage of its net assets.

But some companies by their very nature have high gearing. Such as pharmaceutical companies.

Companies, like pharmaceutical firms, actually have very few tangible assets and so can look highly geared. But they’re usually highly cash generative. Their profits before interest and tax (PBIT) normally cover their interest payments many times.

This means they can still invest in their business, repay debt and pay out dividends.

But remember, by the time a company puts its annual report together and its auditors give it the once over, it can be up to three months before the company publishes it. So bear in mind that any ratios could be out of date.

So there you have it, what you can learn about a company from its balance sheet.

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