How Investment Bankers Can Use the Balance Sheet to Locate Pitfalls and Opportunities - dummies


By Matt Krantz, Robert R. Johnson

Investment bankers can use the balance sheet to their advantage. Consider this: when individuals meet a financial planner, one of the first things they do is create a net worth statement. The net worth statement outlines all the assets owned and all the liabilities owed by the individual.

At just a glance, the financial planner can create a set of priorities for the person to achieve. Similarly, an investment banker can get a quick opinion on a company’s opportunities and deficiencies by looking at the balance sheet, including

  • Opportunity to increase leverage: One of the top tricks of investment banks is helping companies sell debt securities to increase their level of leverage. By deploying more debt, depending on where interest rates are, companies can push their profitability up and appease and please stock holders. When a company uses debt to boost profit, that in turn increases the return on equity invested in the business.

    Increased debt can work both ways for a company. Investors may be pleased by the increased returns by using debt, but the change also increases risk. Greater leverage can be dangerous if a company’s cash flow falls and the interest payments turn onerous. That’s why leverage is often referred to as a “double-edged sword.”

  • Finding uses for cash: A big pile of cash sitting on the balance sheet attracts the attention of investment bankers and makes them salivate like one of Pavlov’s dogs. Especially when interest rates are low, as they were during much of the early 2000s, having cash sitting idly by can have a high opportunity cost, meaning companies are missing out on better returns elsewhere.

    Investment bankers will approach cash-rich companies for possible uses of that cash, including mergers and acquisitions (M&A) activity.