When analyzing a company , whether you want to buy a business or sell a business Balance sheets are one of the 3 financial statements that we use to measure the value of a company and determine its financial health. A balance sheet gives the value of all of the assets and liabilities in a company, and shows the difference between the two as equity. The balance sheet because the assets need to balance the sum of equity and liability.
Now we look at these three major pieces of the balance sheet and understand as to how we use them to research for a healthy and good company.
· The first piece of the balance sheet is called the Asset of the company. Assets can be value of the owned house, value of the car, value of the furniture etc. It does not matter if we owe money on it. We just need to put in what they are worth under the asset of the company. Included in those assets are other other things such as balance of the banking account and balance of the brokerage account.
· The second piece in the balance sheet is called liabilities. Those are the things we owe. Suppose we have a house and we have put the value of that house in the asset, if there is any loan on that house then the cost of the loan amount would be added under liabilities. Similarly, we will do for all the loans.
· The third piece of balance sheet is Equity. It’s just the difference between total value of all the assets and total cost of liabilities.
Now we need to understand what all red flags we need to look for and what makes the balance sheet look really healthy.
Obviously, If the value of assets is more than the liabilities then it’s a positive thing. What we look in the balance sheet is whether the equity is going all the time or not. What it means is that money is really going in the equity into the business all the time. A lot of businesses make money, they have good sales, they have good profits but the profits does not actually make up in the equity of the balance sheet because they turn around and reinvest so as to keep the business running. We want a business where balance sheet is growing.
We also look at the working capital in the balance sheet. Working capital is the current assets (cash in the bank, account receivables) and we subtract the things that we pay out this year. What we see that that when we subtract account payables from the current assets, it should be a positive number. It means that we have a positive working capital. What is expected from a fairly good performing company is a 2:1 ratio between current assets and current liabilities. This is also known as the current ratio.
We at Kapso Business Services, India’s Leading Business Brokers provide business owners what they need and guide them through the entire process. We provide a comprehensive analysis using weighted averages of all the valuation techniques(DCF, market multiple) to give our clients a holistic valuation of the companies.