How to read a balance sheet

1. The three building blocks

Assets are resources controlled by the company. Liabilities are obligations. Equity is the residual interest after liabilities.

2. Current vs non-current

Current assets and liabilities generally relate to the operating cycle or obligations due within the near term. Non-current items extend beyond that horizon. The exact classification depends on accounting standards and the nature of the item.

3. Cash

Cash strengthens liquidity, but not every rupee of cash is necessarily available for distribution. Consider restricted cash, minimum operating balances, subsidiaries and other commitments.

4. Receivables

Receivables are sales for which cash has not yet been collected. If receivables grow materially faster than revenue, investigate customer payment terms, collection quality and whether reported sales are converting into cash.

5. Inventory

Inventory can support growth, but excessive inventory can tie up capital and eventually require write-downs. Compare inventory growth with revenue and production plans.

6. Fixed assets and capital intensity

Factories, machinery and infrastructure create future productive capacity but require capital. Rising assets should eventually support revenue and operating profit; otherwise returns on capital can deteriorate.

7. Intangible assets and goodwill

Acquisitions can create goodwill and identifiable intangible assets. Large balances are not automatically bad, but analysts should understand how they arose and whether the acquired economics justify the price paid.

8. Debt

Separate short-term and long-term borrowing. Examine interest rates, maturities, currency exposure where relevant and covenants when disclosed. Debt can amplify shareholder returns during strong periods and amplify stress when cash flows weaken.

9. Net debt

A common starting point is net debt = total debt − cash and cash equivalents. But analysts should understand what has been included and whether lease liabilities or other obligations need separate consideration.

10. Working capital

Working capital connects the balance sheet to cash flow. Receivables and inventory can consume cash; payables can provide operating financing. Track these items relative to sales and costs over time.

11. Worked example

Revenue grew 20%, but receivables grew 50%, inventory 40% and debt 43%. None proves a problem by itself. Together they create a research question: what is driving the growth, and when will the additional working capital and borrowing generate cash returns?

12. Liquidity and solvency

Liquidity asks whether the company can meet near-term obligations. Solvency asks whether its overall financial structure is sustainable. Current ratio, interest coverage and net debt metrics can provide context, but should be interpreted alongside cash flows and business cyclicality.

13. Balance-sheet red flags

• receivables growing much faster than sales;
• inventory rising without corresponding demand;
• debt rising faster than operating cash generation;
• large unexplained advances or other assets;
• repeated equity dilution to fund operations;
• major related-party balances requiring explanation.

14. Analyst workflow

1. Read the latest balance sheet.
2. Compare at least several years.
3. Calculate net debt and relevant liquidity measures.
4. Track receivables, inventory and payables against operating trends.
5. Read notes to accounts for important obligations.
6. Connect balance-sheet movements to the cash-flow statement.

15. Checklist

• ☐ Cash quality understood
• ☐ Debt and maturities reviewed
• ☐ Net debt calculated consistently
• ☐ Receivables tested
• ☐ Inventory tested
• ☐ Working capital explained
• ☐ Major contingent/other obligations reviewed
• ☐ Changes reconcile with cash flow

Next: follow the cash → Connect capital to returns →