Analyze Balance Sheet For Your Investment Growth [2023]

Do you want to learn everything about balance sheet to make a great investment? This is your Balance Sheet A to Z guide. Here, you will learn the basics of the balance sheet & simple tips on how to analyze the balance sheet of a company.

But, first, let’s start with the basics so that you have a complete picture.

Why do Analyze a Balance Sheet?

There are many other financial statements & tools of fundamental analysis available for investors such as Profit and Loss Statement, P/E Ratio etc. But there is nothing similar to the balance sheet, for the following reasons –

• it is the first step towards Fundamental Analysis. 
• it helps you to determine the financial health and stability of a company.
• it gives you a picture of future prospects of the company.
• It provides many important information where you can compute different financial ratios.

This is so important that before investing, if you just analyze it, you will never regret your investment.

What is a Balance Sheet?

A balance sheet is one of the three financial statements that  shows the position of a company in terms of assets, liabilities and shareholders’ equity at a specific point in time. It is a financial report readily available quarterly, half yearly and annually, shows the financial evolution of a company over the span of time.

How Balance Sheet is Prepared?

According to the name, it is prepared on a flow basis either horizontal in format or vertical in format, in two parts so that each part remains equal numerically.

In horizontal balance sheet, accountants first have to divide the page horizontally into two halves. One half shows liabilities and equity, while the other half shows all assets.

Companies also publish this financial statement vertically. In this format, the top half shows assets, while the bottom half shows liabilities and equity.

Balance Sheet Formula

Balance sheet accountability is in an audited form. As the name suggests, both sides of a balance sheet is always balanced i.e Assets is equal to Liabilities.

The fundamental equation of the balance sheet is expressed more accurately as: Assets = Liabilities + Equity. This is because equity is a form of liabilities, also known as Shareholders’ equity or net worth.

What is in a Balance Sheet?

Every subject has its own terms to describe it and the same thing is here too. The important items of the balance sheet are-

Assets

Any resource owned by a company, tangible or intangible, which has a positive economic value, is an asset for a company. Materialistic things such as real estate,  appliances, office furniture are tangible assets.

While intellectual properties such as company reputation and brand value are intangible assets. Assets are of two types, current and non-current. The assets expected by a company to be converted into cash within one year are called current assets.

Current assets include –

• Money in transit
• Short-term investments
• Inventories
• Cash equivalents.

On the other hand, assets that are not expected to be converted into cash within one year are called non-current assets.

Non-current assets include –

• Real estate (building and land)
• Machinery and equipments
• Intangible assets like patents, trademarks, and goodwill
• Long-term investments

Liabilities

Liabilities are obligations of the company. Liabilities are legal financial debts of the company that the company has taken on due to business operations and are obliged to repay. Liabilities are of two types- current and non-current.

Current liabilities are a company’s obligations which are expected to be settled within one year. While non-current liabilities are a company’s obligations which are expected not to be settled within one year.

If you buy a personal computer on EMI and plan to repay within a few months. This is your ‘current liability’. However if you buy land or flat by seeking a 5-10 years loan from a bank, it is your ‘non-current liability’.

Shareholders’ Equity

It is also called as Shareholders Fund or Net Worth. It is the difference between total assets and total liabilities. In other words, it is the sum of capital reserves and share capital of a company.

Share Capital

Share capital is the fund a company raises by issuing common or preferred stock initially or subsequently. Share Capital of a company is calculated by the formula – 

Share Capital= Face Value x No. of Shares

Capital Reserves and Surplus

Capital Reserves is the profit earned by a company for long term projects. This amount belongs to the shareholders, but cannot be distributed to them as dividend. Surplus is where all the profits of the company reside.

Debt

The amount of money that the company has borrowed through various sources are referred to as debt.

Where to Find the Balance Sheet?

Company’s own website is the best place from where you can find the financial information like balance sheet etc.

If you want to invest in a U.S. public company, you can find it’s financial details in the company’s annual report on Form 10-K filed with the U.S. Securities and Exchange Commission (SEC).

For the companies of Indian Stock Market, moneycontrol, economic times like financial websites are good sources of information. You can find all types of sources link from here.

How to Read the Balance Sheet?

Three terms share capital, reserves and debt as well as one ratio of debt to net worth are important to read the balance sheet. To understand these items easily, you can compare the company to a human being.

Just as money is important to an individual, share capital is important to the company. Share capital is like human property for a company.

Just as salary and debt are important for a human being, the same importance for a company is reserve and debt respectively.

No person wants to repay his debt by selling his assets. Also he wants to grow his income in a regular way. And if he can do it then he is called a successful person.

Similarly, in order to sustain a company in the long run, it should not dilute its share capital to repay its debt and at the same time the company should also increase its reserve.

Debt to Net Worth Ratio

It is the ratio of debt taken by a company to its net worth. Its generally acceptable value is less than 0.6 for investors.

A value greater than 0.6 indicates bad health of the company and even smaller ratio is not considered good for the company. Because it implies that the company is not going to expand its business in near future.

Best Way to Analyze a Balance Sheet

By now you must have learned the basics of balance sheet very well. Let us now learn to analyze it from the point of view of investment.

First of all, you should evaluate the figures of balance sheet for at least 5-6 years to decide which company is good, which is average, or which is bad for your investment.

Good Company –

The share capital of a good company should always be consistent. It should not be diluted. Capital reserve should always grow. And debt should always decrease. And even if it grows, it should not be done so moderately.

It is always beneficial to invest in such companies.

Average or Mediocre Company –

The share capital of an average company always dilutes. Capital Reserve and debt remain almost the same or sometimes debt increases slightly.

One should not invest in such companies or other aspects of fundamental analysis should also be taken into consideration when investing.

Bad Companies –

The share capital of a bad company always increases. Capital Reserve decreases or remains almost the same. But debt goes up a lot.

Do not invest in such companies at all.

You can very easily recognise the status of a company with the help of these pictures.

Balance Sheet Example

Analysis of a Good Company

Image Source: MoneyControl

Let us first look at the balance sheet of Asian paints. Here you have to learn why it is a good company. This sheet is from Mar’15 to Mar’19. As I have mentioned above, you mainly have to take care of three things –

1. Share Capital– its value in Mar’15 is Rs. 95.92 crore which remains constant till Mar’19.
2. Capital Reserve– It has increased from Rs 4646.44 crore to Rs 9423.77 crore in a period of five years, which is more than double.
3. Debt– its debt has also increased during this period but with moderate rate which can be assumed positive for the company because the company sometimes has to increase debt to grow its business.

As it fulfills all the above three conditions of good company. Therefore, you can consider it a company with good financial health.

Analysis of an Average Company

Image Source: MoneyControl

Now look at the annual data of ITC Ltd. Try to understand why it is not a good company. What factors make it an average company? This sheet is also from Mar’15 to Mar’19. When you look at the data you find that –

Share Capital of ITC Ltd. in Mar’15 is Rs. 801.55 cr. which dilutes slightly to Rs. 804.72 cr. in one year. But next year it increases rapidly to Rs. 1214.74 cr. and in subsequent two years dilutes slowly.

This is a negative factor for the company.
Reserve of the company has performed well, increasing consistently from Rs. 30842.59 cr. to Rs. 55917.07 cr. in a period of five years.
Company has also optimized its debt by Rs. 224.72 cr. to Rs. 10.01 cr. in a period of five years.

Despite being reserve and debt positive, as the company has diluted its share capital significantly. Therefore, you should consider it as an average company.

Analysis of a Bad Company

Image Source: MoneyControl

Finally, let us analyze a bad company for your better understanding. For this, you can take an example of Dewan Housing Finance Corporation. To understand why this company has performed poorly in the last five years. Watch data carefully.

Share Capital of this company in Mar’15 is Rs. 145.68 cr. which diluted to Rs. 313.82 cr. in Mar’19. Reserves of the company has increased till Mar’18 but again decreased in next year.

But the worst is the company’s debt. Which has increased so much in the last five years that companies cannot repay their debt even at the cost of their net worth.

I tried to cover as much as I could for you to get started well in share market, but if you still have a question in your mind before starting your investment, feel free to ask via comment.

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