Choosing investments takes a lot of research into a company’s situation, past, present, and future. Periodically, companies make available certain financial statements that convey the firm’s financial position at a certain point in time in the past. The information contained in these statements gives clues to the company’s profitability and ability to compete with other firm’s in the same industry. Luckily, these statements follow certain rules and regulations that allow an investor to understand the corporation at a glance.
The Balance Sheet of a corporation is made up of three main parts. These parts have a relationship with one another which is known as the balance sheet identity. This identity is expressed with the equation:
Assets = Liabilities + Owners’ Equity
However, this identity is often confusing to the beginning investor. With a little math, the balance sheet identity can be rewritten as:
Owners’ Equity = Assets – Liabilities
This rewritten equation makes more sense because it is intuitive that the equity of the owners is made up of what the company is worth (assets) minus what the company owes (liabilities).