Does a Balance Sheet Value a Company?

Many people think that a Balance Sheet values a company. Like many things financial, that’s a myth. A balance sheet has nothing to do with the value of a company.

If you doubt me, pick almost any listed company and compare its market capitalisation (share price X number of shares) with total equity in the balance sheet. Almost always, market capitalisation is higher, often far higher. Why?

Share price is determined by what investors think the company’s future earnings – especially its cash flows – will be. It’s a forward-looking thing.

Equity in the balance sheet is completely different. It’s the total of the cash shareholders have invested in shares, plus profits net of dividends paid since the company’s inception, plus unrealised profit from things like asset revaluations. It’s a backward-looking thing.

Looked at another way, a Balance Sheet shows what has happened, market capitalisation is a kind-of prediction about what will happen.

So, it’s no wonder that a Balance Sheet doesn’t value a company. It’s just one of those mysterious financial myths that are dispelled when Financial Statements are explained in Plain English.

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