One of the primary uses of a balance sheet is to evaluate a company's liquidity or ability to meet its short-term obligations. A company's liquidity can be measured by comparing its current assets to its current liabilities. The current ratio is calculated by dividing current assets by current liabilities. A ratio of 1 or higher is considered a good indicator of liquidity. For example, if a company has $100,000 in current assets and $50,000 in current liabilities, its current ratio would be 2. This means that the company has enough current assets to cover its current liabilities twice over, indicating a high level of liquidity.
Another important use of a balance sheet is to evaluate a company's solvency or ability to meet its long-term obligations. A company's solvency can be measured by comparing its total liabilities to its equity. The debt-to-equity ratio is calculated by dividing total liabilities by total equity. A ratio of 1 or less is generally considered a good indicator of solvency. For example, if a company has $500,000 in total liabilities and $1,000,000 in equity, its debt-to-equity ratio would be 0.5. This means that the company has more equity than debt, indicating a strong level of solvency.
