The balance sheet

In simple terms

The balance sheet is a photograph of a company's finances on a single date, usually the last day of the financial year (31 March for most Indian companies) or of a half-year. It lists three things:

• Assets: everything the company owns or controls that has value.
• Liabilities: everything it owes to others.
• Equity: what is left for the shareholders.

It is built on the accounting equation you met in Assets, liabilities and equity: assets = liabilities + equity. The two sides always add up to the same total, which is where the name "balance sheet" comes from.

The main lines

Indian balance sheets group items into assets on one side, and equity and liabilities on the other, with each group split into non-current (longer than about a year) and current. The order of the groups differs between formats, so look for the headings rather than the position.

Other equity is usually the biggest part of equity for an established company, because it holds the profits retained over many years. Each year's net profit, less dividends paid, is added to it, which is one of the links between the income statement and the balance sheet explained in how the three statements connect.

Worked example

Why it matters

The income statement tells you whether a business makes money; the balance sheet tells you whether it can survive. A profitable company with too much short-term debt can be pushed into crisis by one bad year or a lender who will not roll over a loan. A company with plenty of equity and modest debt can absorb losses and keep investing.

The balance sheet also shows how much capital the business needs. Comparing profit with the equity and debt used to earn it, through measures such as return on equity, is one of the best tests of business quality, covered in the fundamental analysis path.

How to interpret it

• Debt-to-equity: borrowings ÷ equity. Lower means less reliance on lenders. What counts as high depends on the industry: banks and utilities normally carry more debt than software companies.
• Net debt: borrowings − cash. A negative number means the company holds more cash than debt (it is "net cash").
• Working capital: current assets − current liabilities. Positive working capital is a cushion; but if it grows much faster than sales, cash may be getting stuck in stock or unpaid bills. The working capital lesson turns these balances into days.
• Current ratio: current assets ÷ current liabilities. A ratio well above 1 means short-term obligations are covered by assets that should turn into cash within a year, if those assets are sound.
• Trends: compare the same lines over several years. Rising receivables, ballooning borrowings or shrinking equity are questions to investigate.

Limitations

A balance sheet is a snapshot. A company can look healthier on 31 March than it does in October, for example by collecting receivables or paying down short-term loans just before the year end. Many assets are recorded at what they cost minus depreciation, not at what they are worth today, and valuable things such as brands built over decades, customer loyalty and skilled staff often do not appear at all. Some obligations, such as guarantees given for others, may only appear in the notes.

Common mistakes

• Treating "other equity" as cash. It is accumulated profit that has usually been spent on factories, stock and other assets.
• Looking only at total debt. Net debt and the timing of repayments matter just as much.
• Ignoring the notes. Contingent liabilities, pledged assets and related-party balances are explained there.
• Comparing across industries without context. A bank's balance sheet is built very differently from a manufacturer's.

Try it yourself

Open the consolidated balance sheet of a listed company you know and calculate, for the last two year-ends:

1. Total borrowings (long-term plus short-term) and net debt.
2. Debt-to-equity.
3. Working capital.

Then write one sentence on whether the company relies more or less on lenders than it did a year ago.