How to read a balance sheet

Every balance sheet obeys the same identity: assets equal liabilities plus shareholders' equity. Everything the company owns was paid for either by owing someone, or by its owners — through the money they put in and the profits the company kept.

It describes one date, the end of the reporting period. A company can look quite different a few weeks later, and a year-end balance sheet can flatter a business whose cash peaks at that time of year.

Current assets are expected to turn into cash within a year: cash and equivalents, receivables — money customers owe — and inventory. Non-current assets last longer: property, plant and equipment, long-term investments, and intangible assets such as goodwill.

• Receivables growing faster than revenue can mean customers are taking longer to pay.
• Inventory growing faster than sales can mean products are not moving.
• Goodwill is the premium paid for acquisitions above the value of what was acquired. It is written down, not sold, when a deal disappoints.

Current liabilities fall due within a year: supplier bills, short-term borrowings, wages and taxes owed, and deferred revenue — cash customers have already paid for things not yet delivered. Non-current liabilities include long-term debt, leases and pension obligations.

Not every liability is a loan. Deferred revenue in particular is often a sign of a healthy subscription business rather than a burden. That is why net debt — borrowings less cash — is a truer measure of indebtedness than total liabilities.

Equity is what remains after subtracting liabilities from assets. It is made up of the capital shareholders contributed and retained earnings, the profits kept rather than paid out.

Equity can be negative without the company being in difficulty. A business that repurchases large amounts of its own shares reduces its equity with every repurchase, which is why some very profitable companies show negative equity and a debt-to-equity ratio that means little.

Several of the most common ratios come from the balance sheet alone, or from the balance sheet together with the income statement.

• Current ratio: current assets divided by current liabilities. Below 1 means more falls due within a year than is readily available — something some businesses run on comfortably and others cannot.
• Debt to equity: liabilities divided by equity, how much of the company is funded by creditors rather than owners. WylthIQ's version uses total liabilities.
• Net debt: borrowings less cash. A negative figure means more cash than borrowings.
• Return on equity and return on assets: profit from the income statement, set against equity or assets from here.

Assets are mostly recorded at what they cost, less depreciation, not at what they would fetch today. A brand, a customer base or a team of engineers rarely appears at all. Some obligations sit outside the balance sheet entirely and are only described in the notes.