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If you invest in a company without reading its balance sheet, not only do you deserve to lose all of your money but your house should also be broken into and be robbed of everything up to and including the wallpaper trimmings.

If you read my critically acclaimed guide about Reading an Income Statement, you would know just how crucial the income statement is to understanding the financial standing of a company – where else are you going to find out how much money a company is making if any at all?

The same importance applies to the balance sheet, nowhere else will you be able to find how much cash a company is holding, how much money it is recieving, how much money it owes and that little thing we like to refer to as debt.

Just like how you would never consider loaning money to someone who has no income, I would say that it is safe to assume that you wouldn’t be too happy lending out your money to someone who already has more debt than MC Hammer and $3.54 in their bank account – so why would you want to do the same with a stock?

After reading this guide you will be able to take a look at a balance sheet and will have a clear picture of the financial standing of the company. Now couple that with understanding the earnings potential of  said company via the income statement and you will be sailing around in yachts forged out of platinum in no time.

As I promised with the income statement guide and my understanding that reading a balance sheet sounds like as much fun as skinning a chicken to the average person, I will do my best to make this guide as entertaining and informative as humanly possible.  If things start to get a little hazy and you feel your eyes rolling into the back of your head while reaching for a knife to end your misery, just remember to visualize the huge sacks of cash that will come from mastering these crucial skills.

Getting Started

As per the income statement guide, I will be continuing valuating the mighty maker of the mighty Blackberry smartphones, Research in Motion (RIMM). Again, I will be promoting the use of MoneyCentral’s website as it is the most convenient to use and will apply to a wider variety of company valuations.

You can find the link to RIMM’s balance sheet here: http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=rimm&lstStatement=Balance&stmtView=Ann

If you want the significantly more detailed annual report (which you should read anyway), you can find it here: http://moneycentral.msn.com/investor/invsub/results/statemnt.aspx?Symbol=rimm&lstStatement=Balance&stmtView=Ann

It is important to note that this guide will be as useful for financial and commodity stocks as Britney Spears’ dietician. In this guide I will teach you that debt/liabilities are the equivalent to Satan (in most cases) yet if you abide by my rules you will never invest in financial stocks because their whole business model is based on debt. Commodity stocks on the other hand can’t function without taking on a massive amount of debt (in most cases anyway) yet they are able to make people many big fat moneybags.

I might release a special article for reading the balance sheet of financial or commodity stocks in the future, but for now avoid them like the plague…unless of course you feel comfortable gambling your money.

As mentioned before:

At first glance, you will most likely see a whole jumble of numbers and your first instinct will be to buy the length of rope that I sell for discount prices – but before you do that, just take a deep breath and regain your composure. We will go over every little detail together and I will explain to you the meaning and significance (or lack of) for every little word and number.

For your convenience: text under italicized headings can be easily skipped over and it probably won’t affect your multiples of moneybags very much – but I would still recommend you read it so that you understand all the little intricacies that come with rolling around in giant piles of cash.

Understanding the Balance Sheet

At first glance, the balance sheet may seem as confusing as the United States’ exit strategy from Iraq, but just by remembering one very simple tidbit of information will make your life significantly easier: the balance sheet must balance. There’s a reason it’s called the balance sheet!

As you go down the balance sheet you will see the heading Assets followed by Liabilities and Shareholder’s Equity shortly after (with many scary numbers in between). The balance sheet abides by one very simple equation:

Assets – Liabilities = Equity

This equation can be arranged to make:

Assets = Liabilities + Equity; meaning assets have to equal liabilities plus equity – they have to balance.

In case you are currently left scratching your head about all these terrifying terms: assets are something of value that are owned by the company, liabilities are what the company owes, and equity is what is left once you subtract what a company owes from the value of its holdings – it is what can be taken home in the end. In the case of stocks, Equity is known as Shareholder’s Equity.

Assets and Liabilities can be split up into two categories, Current Assets/Liabilities and Long-Term Assets/Liabilities. Add Current Assets to Long-Term Assets and you will get Total Assets or add Current Liabilities to Long-Term Liabilities and you will get Total Liabilities. It’s all quite simple.

I will go further into detail about each category in the next parts of this guide, but knowing these few tidbits of information can help you understand what it is that I am talking about exponentially better.

General Balance Sheet Information

At the very top of the balance sheet you will notice this jumble of numbers and words:

Head on over to the first part of my Reading an Income Statement guide if you are having trouble understanding these numbers. Once you are finished, come back to this page and we will get started with the REAL balance sheet information – you know, the stuff that will prevent you from saying “Whoops I didn’t know the company I invested in was hundreds of millions of dollars in debt, not receiving any new money and burning through cash faster than you can say plum sauce.”

(Coming Soon!)

Part One: Current Assets

Part Two: Total Assets

Part Three: Current Liabilities

Part Four: Total Liabilities and Equity

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