Reading the Balance Sheet: Liabilities and Shareholder Equity
When choosing a dividend stock for your portfolio, it is important to consider your options, including the health of the company and what its balance sheet looks like. Recently, we considered the side of the balance sheet containing a company’s assets. Now it’s time to look at the other side of the balance sheet – the side containing liabilities.
Assets are those items that contribute value to a company. Assets provide value that can provide funding to the business. Liabilities, though, are obligations to others. This is usually money owed to other companies, or to suppliers, or for some other purpose. There are two main types of liabilities:
- Current: Current liabilities are those that are paid within the time period of one year. Accounts payable is one example of a current liability. A business normally has to discharge those obligations within a year. Additionally, long-term obligations that are paid within a year are also considered current. So the amount of the interest that is paid on a 20-year loan during the course of the year is considered a current liability.
- Long term: A long-term liability is one that does not need to be paid until after a year. This can include non-debt financial obligations, such as an agreement to pay a certain amount of money for a shipment of goods at a later date, as well as debt obligations.
Company liabilities offset the assets, since they represent a drain on the resources of a company.
Interestingly enough, shareholder equity actually goes on the same side of the balance sheet as liabilities. Shareholder equity represents the amount of money invested in the business at the outset. Shareholder equity can increase if the company decides to take some of its earnings and invest them back into the company.
When reading a balance sheet, you will find it divided into two sides. On side the assets will be listed, and on the other side the liabilities and shareholder equity will be listed. As the name “balance” sheet implies, the two sides are supposed to even out. The assets a company has should equal the liabilities plus shareholder equity, and you should see how that comes about. If a balance sheet doesn’t balance, it’s important to look into the numbers to find out why.
As you look at the balance sheet, compare the two sides. You will have an idea of what the company owns, and what its obligations are. If a company appears to be highly leveraged, with lots of debt in comparison to assets, you know that the company is risky. A balance sheet can provide clues about how a company uses money, and that, in turn, can help you decide whether or not to include the investment in your dividend portfolio.