Explain the signs that indicate balance sheet quality
The idea
A high-quality balance sheet is complete, unbiasedly measured and clearly presented. Completeness means obligations are not hidden off balance sheet through purchase commitments, guarantees, structured entities or factoring with recourse. Measurement matters for assets and liabilities that rely on judgement: goodwill and other intangibles, pension obligations, fair value estimates using unobservable inputs, and reserves. Large goodwill relative to equity signals exposure to impairment. Clear presentation means items are classified sensibly, for instance receivables not buried in other assets. Signs of weakness include rising goodwill without matching earnings, heavy use of Level 3 fair values, and unusual changes in classification. The trap is assuming the balance sheet is neutral because it balances; judgement shapes most large items.
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