Thursday, March 5, 2009

Learn the Lingo: Balance Sheets

It's not breaking news that most stocks have gone to hell in a Marc Jacobs handbag. With General Motors now trading for under $2 per share, and Citigroup trading under $1, sometimes it feels like this is The End, beautiful friend. (Thanks, Jim Morrison.) Eventually though, whether it be next year or 5 years from now, stocks will rebound and there will come a time when you may *gasp* actually consider investing your money in the markets.

And when that time comes (fingers crossed), you'll be happy you know all the lingo surrounding stocks and trading, right? If you're ever going to invest in the market, you'll need to know the basics. Trust me, you don't want to be stuck at a cocktail party, nodding along cluelessly as those around you discuss balance sheets and debt-to-income ratios. It's not a pretty sight.

That vacation house in Acapulco will always be a pipe dream if you aren't willing to put in the work to get there. Fortunately for you, the work is piece of chocolate ice-cream cake (zero calories, of course).

Not understanding the nitty-gritty in finance (such as what a stock is) would be like trying to do open heart surgery without knowing which heart valve connects to what. Imagine your pot of money as your patient, and you are the doctor. Do you want your patient to live longer and grow, or do you want it to disintegrate and fall apart? I don't know about your neck of the woods, but in mine, it's just considered poor form for a doctor to operate without understanding the fundamentals. This analogy should extend into your fiscal life. Ok, so maybe the stock market, money market funds, CDs, etc. aren't as complicated as open heart surgery, but a gal needs to keep her wits about her when money is involved, which means learning working knowledge of the basics, or terms.

And the term du jour is balance sheet, or a statement of what a company, let's say Google, is worth on the date it's printed. Balance sheets are typically divvied up to you, the shareholder, about four times per year, or every quarter.

Still with me? If you see anything about a "Google's Q1 2008 profits," for example, that means the profits were reported in the first quarter of 2008 balance sheet. Q1, Q2, Q3 and Q4 all relate to which quarter is being reported, and is usually followed with corresponding year. So if you hear about predictions for Google's Q3 09, that would be their third quarter of 2009. Pretty snazzy.

What's on a balance sheet, you ask? Simple. There are three key elements to a balance sheet you should worry about. These include:

Assets, which is another way of saying the financial value of a company. Assets can include anything that could be converted to cash, such as property the company owns, office equipment, etc. On balance sheets, though, assets are usually the sum of liabilities (more on that in a sec -- stay with me!), stock and "retained earnings" (aka earnings that are reinvested in the core business or used to pay off company debt).

Liabilities, or debt the company has.

The Net Worth of a company, which is just the assets minus the liabilities. It gives you a clearer picture of how much said company is really worth.

Whew, that wasn't too hard, right? I know it all sounds dreadfully dull, but you can't increase your savings and buy that Birkin bag without knowing the facts!

Now that you're a whiz when it comes to all things asset- and liability-related, balance sheets are usually split into two parts:

  • The first part lists what the company's current assets and liabilites are.
  • The second part shows how these assets and liabilites were paid for. The totals for each of these parts have to be equal.

One warning, though. Before you start thinking that all you need is a company's balance sheet before you decide to invest in them or not, you also need to look at the company's income statement, which discusses revenue and expenses. But that's a whole other post unto itself.

The balance sheet is simply one of the many statements that gives you, the shareholder, a better understanding of what you're getting into with a company. For example, if you're considering buying stock in a company with a massive amount of liability (or debt) on their balance sheet, you probably don't want to place your chips on the table with them just yet. After all, every brunette on a budget needs to know when to hold 'em -- and the balance sheet is a great first step in telling you how to play your cards, or savings, accordingly.

And with that, chickadees, I'm off to the warmer pastures of Las Vegas for a long weekend of free drinks, blackjack tables, and possible K-Fed sightings. Arrivederci!


FB @ said...

You must have read my mind!

I did posts on how to read each financial statement about 3 weeks ago as future scheduled posts :)

Crystal said...

Further proof we are brilliant! ;D

paisley penguin said...

Then there is my CFO's absolute FAVORITE word - EBITDA (earnings before interest, taxes, depreciation & amoritization). If you really want to get down and dirty!

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