How to Decide What Is a Strong Balance Sheet

How to Decide What Is a Strong Balance Sheet
The balance sheet is one of the fundamental financial statements.

Step 1

Examine the company’s assets. Determine whether the company has enough current assets to pay its financial obligations. A company that has more liabilities than assets is considered financially weak. Even though a company may have a significant amount of current assets, it is not the only to factor to consider.

Step 2

Calculate the current ratio by dividing the total of a company’s current assets by current liabilities. The current ratio is used to measure a company's liquidity. A current ratio of 1 or greater is preferable when deciding the financial strength of a company, according to the Financial Speculation website.

Step 3

Calculate the quick ratio by subtracting inventory from current assets and dividing that result by current liabilities. The quick ratio is a more accurate measurement of a company’s ability to pay its debts. A quick ratio higher than 1 means that company is in a good financial position.

Step 4

Calculate the cash-to-debt ratio by adding cash and short-term investments and dividing that total by current and long-term liabilities. It is important for a company to earn a high percentage of its cash from its operations and not from having a lot of debt. A favorable cash-to-debt ratio is anything equal to or exceeding 1.5.

Step 5

Calculate the debt-to-equity ratio by dividing the total amount of a company’s liabilities by shareholders’ equity. The debt-to-equity ratio determines the amount of debt and equity a company uses to purchase assets. If the ratio is lower than 1, it means that a company is purchasing most of its assets with equity, which shows financial strength.

Step 6

Examine past trends. To further determine the strength of a balance sheet, you should analyze positive and negative trends within a company. Determine whether important data on the balance sheet is improving or declining over time. Compare the financial data of the balance sheet to similar companies' balance sheets and industry ratios.