The Balance Sheet
The balance sheet is a record of the company’s assets and liabilities on a particular date. In a sense, it is a snapshot of the financial health of the company at a particular point in time. It is prepared with the cash flow and income statement. An options trader or an investor can study the balance sheet with the cash flow statement and the income statement to arrive at a conclusion of the company’s financial health.
The balance sheet is also reflected in the company’s quarterly and half yearly report.
The balance sheet can be further classified into current assets, non-current assets, current liabilities and non-current liabilities. When all the liabilities are deducted from the assets, that value is equivalent to shareholders’ equity. If shareholders’ equity is a growing figure throughout the years, it also means that the company is growing its net asset base. This is a good sign as it points to profit making in the years before.
Example
Over a span of 3 years, a company is seen to be earning losses. On top of that, it can be seen from the balance sheet that it not only has mounting debts, but also, its tangible book value has decreased over time. This may be an indication that the company is utilising money on projects that have a very low return on capital.
On the other hand, if a company has decreasing debt levels over the years and is earning a reasonable profit over the years, the book value would automatically have been increasing over the years. With an expansion of book value, the value of the company could be appraised upwards by the market. So in an instance like this, if an options trader sees upside, the trader could buy call options on the company with an appropriate expiration date.
Read also: Shareholders’ Equity