Balance Sheet Analysis - Hiddent Secrets

It may surprise you to know that not everyone is as enthusiastic about Balance Sheet Analysis as I am... And yet, a few minutes a month spent looking at your Balance Sheet could make a difference between success and failure for your business! Those "secrets" alluded to in the article title are hidden only to those who don't know where to look. So, let me show you just a fraction of what the Balance Sheet can tell you about your business and how it wan warn you about possible dangers ahead. Solvency Ratios - Red flags to look for before it's too late The solvency ratios are meant to show us whether the company can sustain itself long–term. In other words – whether it is solvent, or not. And even before then - they show us whether the company is carrying too much debt. And that is a red flag you do not want to miss! One of the hardest things to watch is when an otherwise good company struggles because of excessive debt. The first solvency ratio we will cover is: Debt to Asset Ratio = Total liabilities / Total Assets Debt to Asset Ratio will show you how much of the company's assets is financed through debt. In general, anything over 100% is risky. In fact, if your debt to asset ratio is higher tha 100%, it is the equivalent of being upside down on your mortgage. Companies with high debt to asset ratios are placing themselves at risk, especially in a market with increasing interest rates. Creditors will start to get worried, if the company carries a large amount of debt and may demand that some of it is paid back. Our second solvency ratio is Debt to Equity Ratio = Total liabilities / Shareholders Equity Debt to Equity Ratio shows the proportion of equity and debt that the company is using to finance its assets. Sometimes only long term debt is used instead of total liabilities for a more stringent test: Debt to Equity Ratio = Total Long-Term Debt / Shareholders Equity This ratio is also often described as an indicator of financial leverage. If debt to equity ratio is greater tha 100%, it means that the assets are primarily financed with debt. If it is less tha 100%, it means that equity provides a majority of the financing. If debt to equity ratio is high (the company is financed more with debt), it means that the company is in a risky position – especially if interest rates are on the rise. Just a reminder - as with any other financial analysis, we need to look at the whole picture when evaluating any single balance sheet or profit and loss ratio. The age of the company, the stage the company is at in its growth cycle, the management team in terms its of risk-aversion or risk-friendliness, their financial resources - all of it needs to be considered. I encourage you to look at your balance sheet ratios, and in particular your solvency ratios regularly. They are very easy to calculate - it won't take you more than a few minutes and yet the information is indispensable. Once you get in the habit of analyzing your Balance Sheet regularly, you won't believe you didn't do it before! You will never again allow yourself to accumulate debt to become more leveraged than you intended to. You know that it can get pretty tricky and difficult to get out of, especially in the current economic climate.