Chapter 7 of 15
How to Read a Balance Sheet
Assets, liabilities, equity explained clearly.
Raksha had been running two restaurants for six years. She knew exactly what a balance sheet felt like, she just didn't know it was called that.
She knew: we own this building (or we owe rent). We have ₹3.5 lakhs in the bank. We owe the vegetable supplier ₹80,000 from last week. We have kitchen equipment worth ₹18 lakhs (though honestly half of it is old). My investment in this restaurant is about ₹40 lakhs all told.
That's a balance sheet. She'd been reading one without knowing the formal name.
Now she wanted to pick up annual reports of listed restaurant chains to see if they were worth investing in. And the formal balance sheet, with its structured layout and accounting jargon, suddenly looked alien.
Let's translate it back to what Raksha already knows.
What Is a Balance Sheet?
A balance sheet is a snapshot of what a company owns (assets), what it owes (liabilities), and what belongs to the owners after all debts are paid (equity), all at a single point in time, typically the end of the financial year.
The fundamental equation that never changes:
Assets = Liabilities + Equity
Or rearranged: Equity = Assets − Liabilities
This is the most important equation in accounting. Everything on a balance sheet follows from it.
Think of it this way for Raksha's restaurant:
- Assets = the kitchen equipment, furniture, cash, food inventory, money customers owe you
- Liabilities = the loan you took to set up, money you owe suppliers, rent advance received
- Equity = what's actually yours after subtracting everything you owe
The Left Side: Assets
The balance sheet is typically divided into two sides. Assets on one side. Liabilities and equity on the other. The two must always be equal, that's why it's called a "balance" sheet.
Assets are further split into:
Non-Current Assets (Fixed Assets): Things owned for long-term use:
- Property, plant and equipment (PPE): Building, kitchen equipment, delivery vehicles
- Intangible assets: Brand name, licenses, software
- Long-term investments
Current Assets: Things expected to convert to cash within 12 months:
- Cash and bank balances
- Accounts receivable (money customers owe you: called "trade receivables")
- Inventory (raw materials, work-in-progress, finished goods)
- Short-term investments
Raksha's restaurant assets: Cash ₹3.5L + Kitchen equipment ₹18L + Furniture ₹8L + Vegetable inventory ₹1.2L + Customer advance deposits ₹0.5L = Total assets ~₹31.2L. A listed restaurant chain's balance sheet looks the same, just with more zeroes and broken into formal categories. Kitchen equipment = "Plant and Equipment" under PPE. Vegetable inventory = "Inventories" under current assets. Customer advances received = "Other current liabilities." The structure is identical.
The Right Side: Liabilities and Equity
Non-Current Liabilities: Debt and obligations due after 12 months:
- Long-term bank loans
- Deferred tax liabilities (a tax accounting concept)
Current Liabilities: Obligations due within 12 months:
- Accounts payable (trade payables): Money you owe suppliers
- Short-term borrowings: Overdraft, working capital loans
- Advance received from customers
- Current portion of long-term debt (installments due this year)
Equity (Shareholder Funds): What belongs to the owners:
- Share capital: The face value of all shares issued (usually very small number)
- Reserves and surplus: Accumulated profits over the years that weren't paid as dividend
If a company has issued 10 crore shares at face value ₹10, the share capital is ₹100 crore. But the market cap might be ₹10,000 crore. The difference is in reserves, decades of accumulated profits. Share capital is a historical artefact. What matters is total equity (share capital + reserves).
Working Capital: The Number Raksha Understands Best
Working Capital = Current Assets − Current Liabilities. It measures a company's short-term financial health, whether it has enough liquid resources to cover immediate obligations.
Raksha knows this intimately. On the 5th of every month, she has to pay salaries (₹2.8L), supplier bills (₹1.2L), and electricity (₹0.4L). That's ₹4.4L going out. If her cash and receivables total only ₹3L, she has a working capital crunch, she needs to either delay payment or use overdraft.
For listed companies:
- Positive working capital = can meet short-term obligations without stress
- Negative working capital = potential cash crunch (or, for some retail businesses, a sign of power over suppliers)
Supermarkets and FMCG distributors often have negative working capital intentionally. They collect cash from customers immediately (daily), but pay suppliers in 30–60 days. This means suppliers are essentially funding their operations, it's a sign of extreme bargaining power. D-Mart (Avenue Supermarts) famously operates this way.
Key Ratios Derived from the Balance Sheet
Debt-to-Equity Ratio
D/E = Total Debt ÷ Total Equity. The lower, the better for most businesses. Raksha's restaurant has a loan of ₹15L against equity of ₹40L. D/E of 0.375. That's comfortable.
Current Ratio
Current Ratio = Current Assets ÷ Current Liabilities. Ideally above 1.5. Below 1 means current liabilities exceed current assets, potential liquidity stress.
Asset Turnover
Asset Turnover = Revenue ÷ Total Assets. Measures how efficiently assets generate revenue. Higher is better. A restaurant that generates ₹1 crore revenue from ₹30L in assets is more efficient than one generating ₹50L revenue from the same asset base.
| Ratio | Formula | Good Sign | Warning Sign |
|---|---|---|---|
| Debt-to-Equity | Total Debt ÷ Equity | Below 1 for non-financials | Rising D/E with falling profits |
| Current Ratio | Current Assets ÷ Current Liabilities | 1.5–3× | Below 1 (unless strategic like D-Mart) |
| Asset Turnover | Revenue ÷ Total Assets | Rising or stable | Declining, assets becoming less productive |
| Cash as % of assets | Cash ÷ Total Assets | 10–20%+ | Very low cash with high debt |
What To Look for When Reading a Balance Sheet
Raksha's approach, as a business owner, is naturally strong. She asks the questions that matter:
1. Is the company asset-heavy or asset-light? A manufacturing company needs lots of physical assets. A software company doesn't. Asset-light businesses with high returns on assets are often the most valuable.
2. How much debt does it carry, and is it rising or falling? Debt to expand into high-return opportunities is acceptable. Debt to cover operating losses is dangerous.
3. Is cash position strong? Cash-rich companies have flexibility. Cash-poor companies with high debt have no room for error.
4. What's the quality of receivables? If a company's receivables (money owed by customers) are growing faster than revenue, it could mean customers are paying slower, or the company is recognising revenue prematurely.
5. Hidden liabilities? Check the notes to accounts for contingent liabilities, legal disputes, guarantees given to subsidiaries, pending tax demands. These don't appear on the main balance sheet but can become real obligations.
Some companies keep liabilities "off balance sheet" through leasing arrangements, Special Purpose Vehicles (SPVs), or performance guarantees. Ind AS 116 (lease accounting standard) now requires most leases to appear on the balance sheet, but check the notes carefully for anything unusual, especially for infrastructure and airline companies.
Raksha pulls up the balance sheet of a listed quick-service restaurant chain. Total assets: ₹850 crore. Non-current assets (property, kitchens, franchise rights): ₹620 crore. Current assets: ₹230 crore (cash ₹180 crore, receivables ₹30 crore, inventory ₹20 crore). Total liabilities: ₹340 crore (long-term lease obligations ₹280 crore, trade payables ₹60 crore). Equity: ₹510 crore. Raksha's read: healthy cash position (₹180 crore), low trade payables (good supplier relationships), major liability is lease obligations (this is a restaurant, of course they lease locations). D/E is manageable. Working capital is positive. She likes what she sees.
Key Takeaways
- Balance sheet = what a company owns (assets), owes (liabilities), and what's left for owners (equity)
- Assets = Liabilities + Equity: the fundamental equation that always holds
- Working capital (current assets minus current liabilities) measures short-term financial health
- Watch D/E ratio, current ratio, and cash levels: and track their trend over 3–5 years
- Negative working capital isn't always bad: for retail businesses, it can signal power over suppliers
- Always check notes to accounts for contingent liabilities and off-balance-sheet items
Next, learn how to read a P&L statement, the income side of the story, or explore financial ratios to put numbers in context.
A company has current assets of ₹80 crore and current liabilities of ₹120 crore. What does this tell you?
Disclaimer: This article is for educational purposes only and does not constitute personalized financial advice. Investments are subject to market risks. Past performance does not guarantee future returns. Please consult a SEBI-registered investment adviser before making investment decisions.