Analysis of Balance Sheets

Analysis of Balance Sheets | CFA Level I FSA

Welcome back! We’re diving into some techniques for analysing a balance sheet. Analyzing a company’s balance sheet can provide insight into the company’s liquidity and solvency, as well as the economic resources the company controls. We’ll examine the balance sheets for 2 hypothetical companies, Giant and Pixie, to help us with our analysis.

Liquidity and Solvency Ratios

One commonly used tool is to convert balance sheet figures into ratios. There are two main classes of balance sheet ratios:

  • Liquidity Ratios: These measure the firm’s ability to satisfy its short-term obligations.
  • Solvency Ratios: These measure the firm’s ability to satisfy its long-term obligations.

Liquidity Ratios

Liquidity ratios evaluate if the amount of liquid assets are sufficient to satisfy the short-term debt due within a year. Common liquidity ratios include:

Solvency Ratios

Solvency ratios should be considered collectively to form a more accurate picture of a company’s solvency situation. Common solvency ratios include:

Common-size Analysis

Common-size analysis can be prepared by expressing each item of the balance sheet as a percentage of total assets. This eliminates the size effect and allows for more effective comparison between companies.

Common-size analysis can also be used to examine a firm’s strategies. For example, a significant amount of goodwill might indicate growth through acquisitions, and a high percentage of liabilities could suggest that the firm is financing these acquisitions with debt.

There are two types of common-size analysis:

  • Cross-sectional: Compares ratios across companies.
  • Time-series: Compares ratios for the same company across different time periods, helping analysts identify trends over time.

That wraps up this topic on understanding balance sheets. We’ll move to understanding cash flow statements in the next lesson. See you soon!

✨ Visual Learning Unleashed! ✨ [Premium]

Elevate your learning with our captivating animation video—exclusive to Premium members! Watch this lesson in much more detail with vivid visuals that enhance understanding and make lessons truly come alive. 🎬

Unlock the power of visual learning—upgrade to Premium and click the link NOW! 🌟