Advantages and Disadvantages of a Balance Sheet

Advantages and Disadvantages of a Balance Sheet
A woman is analyzing a balance sheet.

Advantages

Balance sheets are formatted to allow an experienced investor to form a well-informed opinion of a company's risk and return prospects. You can calculate financial ratios using various balance sheet items, using them to obtain a very thorough summary of the company's financial health by analyzing its cash position, working capital, liquidity and leverage. This provides insight into the company's likelihood of defaulting on its credit obligations or even its bankruptcy risk. Also, balance sheet items allow you to assess a company's asset turnover rates -- a measure of how efficiently a company uses its assets -- and key profitability and return measures such as return on equity.

Disadvantages

Because the balance sheet is a snapshot of financial position at a given point in time, its figures can be misleading. For example, a company's cash position at year-end may appear very high, implying strong liquidity reserves. However, it may be the company's intent to distribute a large portion of that cash to shareholders in the form of a dividend, which would distort your analysis. Also, balance sheet figures alone can be less informative without benchmark data from peer companies used for comparison. This can be complicated by companies using different accounting conventions, which can distort balance sheet measures. Finally, many balance sheet items, such as fixed assets, are reported at their historical cost basis -- the amount an asset was purchased for -- which often has little to do with their fair market value, which is more meaningful.