What is a Balance Sheet?
The balance sheet — officially called the Statement of Financial Position under IAS 1 — shows a company's financial position at a single point in time. Unlike the income statement (which covers a period), the balance sheet is a photograph taken on one day, typically the last day of the quarter or fiscal year.
Warren Buffett has consistently emphasized the balance sheet over the income statement. In his annual letters to Berkshire Hathaway shareholders, he warns that earnings can be engineered, but the balance sheet is harder to fake over time.
The Fundamental Accounting Equation
What the company owns must equal what it owes (to creditors) plus what belongs to shareholders. If the numbers don't balance, there's an accounting error.
Assets: What the Company Owns
Current vs Non-Current Assets
Current assets can be converted to cash within 12 months — cash, receivables, inventory. Non-current assets are long-term: property, equipment, goodwill from acquisitions. The AccountingTools guide to current assets is a practical reference.
Goodwill deserves special attention: it's created when a company overpays for an acquisition, and if that business underperforms, the goodwill gets "impaired" — wiping billions from the balance sheet overnight. IFRS 3 governs how goodwill is recorded and tested.
Liabilities: What the Company Owes
Liabilities are the obligations a company must eventually pay. Current liabilities (due within 12 months) include accounts payable and short-term loans. Non-current liabilities include long-term bonds, pension obligations, and deferred tax liabilities.
Debt is not inherently bad — it can amplify returns. But too much debt relative to equity creates fragility. The Federal Reserve's Financial Accounts data tracks corporate leverage trends across U.S. sectors.
Shareholders' Equity
Equity is the residual interest — what's left for shareholders after all liabilities are paid. It consists of paid-in capital (money investors put in) plus retained earnings (profits kept in the business rather than paid as dividends).
A company with negative equity technically owes more than it owns. This can be a warning sign, or it can be intentional (companies like McDonald's have negative equity due to aggressive share buybacks). Context matters enormously — see Investopedia on negative shareholders' equity.
Key Balance Sheet Ratios
| Ratio | Formula | What It Measures | Healthy Range |
|---|---|---|---|
| Current Ratio | Current Assets ÷ Current Liabilities | Short-term liquidity | 1.5x – 3.0x |
| Quick Ratio | (Current Assets – Inventory) ÷ Current Liabilities | Liquid assets coverage | > 1.0x |
| Debt/Equity | Total Debt ÷ Total Equity | Financial leverage | Varies by sector |
| Price/Book (P/B) | Market Cap ÷ Book Value of Equity | Market premium over assets | < 1x = potentially undervalued |
| Asset Turnover | Revenue ÷ Total Assets | Efficiency of asset use | Higher is better |
The CFA Institute's Financial Analysis Techniques chapter provides a rigorous treatment of all these ratios with worked examples.
Balance Sheet Red Flags
Rapidly growing inventory: Inventory growing faster than sales may indicate unsold products building up — demand is weakening. This preceded several retail collapses documented by The Wall Street Journal.
Large intangible assets and goodwill relative to total assets: If 60%+ of assets are intangible, a single impairment charge can devastate book value. Academic research on goodwill impairment shows these write-downs often follow acquisitions done at peak valuations.
Debt due within 12 months that the company can't refinance: Check the current portion of long-term debt against cash on hand. If debt is maturing and cash is insufficient, the company may face a liquidity crisis.
Compare the balance sheet over 3–5 years, not just the latest period. Deterioration in the current ratio, rising debt, or shrinking book value over time tells a more revealing story than any single snapshot.