Long-term investors should study companies' balance sheets to see how sturdy the underlying businesses are and whether their financial health is improving or failing.
For example, consider Wal-Mart's balance sheet for the fiscal year that ended Jan. 31, 2007. We see $7.4 billion in cash and cash equivalents, up 15 percent from the previous year. A growing pile of cash is generally promising. (Some companies have so much cash, though, that it would make sense for them to start paying or increasing dividends if they cannot come up with a better use of the money.)
You usually want to see little or no debt. Between 2006 and 2007, Wal-Mart's total debt rose just 1 percent, totaling $39 billion. The small size of the increase is good, but that is a sizable level of debt. Still, there is enough cash on hand to pay off most of the short-term debt (due within a year). A peek at the footnotes reveals debt interest rates. Low rates suggest the firm is financing operations effectively.
Next up, inventory. Wal-Mart's grew about 5 percent, to $33.7 billion in 2007. Rising inventories can indicate unsold products languishing on shelves, but since sales rose roughly 10 percent year-over-year, inventory appears well under control. (Ideally, sales growth should outpace inventory growth.)
It is also good to measure inventory turnover, reflecting how many times a year the firm sells out its inventory. Take 2007's cost of goods sold (from the income statement) of $264 billion, and divide it by the average of 2006 and 2007 inventory ($32.9 billion). This gives us a turnover of 8.0, up from last year's number of 7.8. The higher the number, the better, so this is a promising trend.
Accounts receivable represent money owed to the firm. Ideally, they should not grow faster than sales. Wal-Mart's rose 6.7 percent. A drop would suggest that it is increasingly getting paid on time because of its clout.