Balance Sheet — Key Terms
Assets (what the company owns)
- Current Assets – convertible to cash within a year (cash, receivables, inventory, prepaid expenses)
- Non-Current/Fixed Assets – long-term holdings (property, plant, equipment, intangibles like patents/goodwill)
- Inventory – goods held for sale or production
- Accounts Receivable – money owed by customers
Liabilities (what the company owes)
- Current Liabilities – due within a year (accounts payable, short-term debt, accrued expenses)
- Non-Current Liabilities – long-term debt, deferred tax liabilities, bonds payable
- Accounts Payable – money owed to suppliers
Equity (owners’ stake)
- Share Capital – funds raised by issuing shares
- Retained Earnings – cumulative profits kept in the business (not paid as dividends)
- Reserves – funds set aside for specific purposes
Core identity: Assets = Liabilities + Equity
Important Ratios for Assessment
1. Liquidity Ratios (short-term solvency)
- Current Ratio = Current Assets / Current Liabilities
- Quick Ratio = (Current Assets − Inventory) / Current Liabilities
2. Solvency/Leverage Ratios (long-term financial risk)
- Debt-to-Equity = Total Liabilities / Shareholders’ Equity
- Debt Ratio = Total Liabilities / Total Assets
3. Efficiency Ratios (how well assets are used)
- Asset Turnover = Net Sales / Total Assets
- Inventory Turnover = Cost of Goods Sold / Average Inventory
- Receivables Turnover = Net Credit Sales / Average Accounts Receivable
4. Profitability Ratios (using balance sheet + income statement)
- Return on Assets (ROA) = Net Income / Total Assets
- Return on Equity (ROE) = Net Income / Shareholders’ Equity
5. Valuation Ratios
- Book Value per Share = (Total Equity − Preferred Equity) / Shares Outstanding
Here’s the same balance sheet and ratios in Rupees (₹):
Item | Amount (₹) |
Cash | 20,000 |
Accounts Receivable | 30,000 |
Inventory | 50,000 |
Total Current Assets | 1,00,000 |
Property, Plant & Equipment | 1,50,000 |
Total Assets | 2,50,000 |
Accounts Payable | 25,000 |
Short-term Debt | 15,000 |
Total Current Liabilities | 40,000 |
Long-term Debt | 60,000 |
Total Liabilities | 1,00,000 |
Shareholders’ Equity | 1,50,000 |
- Current Ratio = ₹1,00,000 / ₹40,000 = 2.5
- Quick Ratio = (₹1,00,000 − ₹50,000) / ₹40,000 = 1.25
- Debt-to-Equity = ₹1,00,000 / ₹1,50,000 = 0.67
- Debt Ratio = ₹1,00,000 / ₹2,50,000 = 0.40
- Asset Turnover = ₹3,00,000 / ₹2,50,000 = 1.2
- Inventory Turnover = ₹1,80,000 / ₹45,000 = 4.0
- ROA = ₹30,000 / ₹2,50,000 = 12%
- ROE = ₹30,000 / ₹1,50,000 = 20%
Key Parameters to Check Before Buying a Share
1. Valuation Ratios
- P/E Ratio (Price / Earnings per Share) – how much you pay per ₹1 of earnings; compare to industry average
- P/B Ratio (Price / Book Value per Share) – price relative to net asset value
- PEG Ratio (P/E / Earnings Growth Rate) – valuation adjusted for growth
2. Profitability
- ROE (Return on Equity) – how efficiently the company uses shareholder money
- ROCE (Return on Capital Employed) – returns generated on all capital, debt + equity
- Net Profit Margin – Net Income / Revenue
3. Financial Health / Risk
- Debt-to-Equity Ratio – too high means high financial risk
- Current Ratio / Quick Ratio – ability to meet short-term obligations
- Interest Coverage Ratio (EBIT / Interest Expense) – can the company comfortably pay interest on its debt
4. Growth Trends
- Revenue Growth (YoY, 3–5 yr CAGR)
- EPS Growth – consistent earnings growth over time
- Promoter/Management shareholding trend – increasing stake is a positive signal, declining stake can be a red flag
5. Cash Flow Quality
- Operating Cash Flow – should be positive and ideally growing, not just paper profits
- Free Cash Flow – cash left after capital expenditure, shows real financial flexibility
6. Dividend (if income-focused)
- Dividend Yield – Dividend per Share / Share Price
- Payout Ratio – % of profit paid as dividends (very high payout may limit reinvestment)
7. Qualitative Factors
- Industry outlook and competitive position (moat)
- Corporate governance and management track record
- Regulatory or litigation risks
Quick sanity checks people often skip:
- Compare all ratios against industry peers, not in isolation
- Look at 5-year trend, not just one year’s snapshot
- Check for red flags: rising debt, falling margins, frequent auditor changes, promoter pledging shares
Typical Healthy Benchmarks (India context)
Valuation
- P/E Ratio: Lower than or close to industry average (varies by sector — IT ~20-30x, banks ~10-20x, FMCG ~40-60x)
- P/B Ratio: < 3 is generally reasonable; < 1 can mean undervalued or troubled
- PEG Ratio: ≤ 1 is considered fairly valued relative to growth; > 2 often overvalued
Profitability
- ROE: > 15% is considered good; > 20% is excellent
- ROCE: > 15%, and ideally ROCE > cost of capital
- Net Profit Margin: Varies by sector, but consistently positive and stable/improving is the key signal, not an absolute number
Financial Health
- Debt-to-Equity: < 1 is healthy; < 0.5 is conservative/strong; > 2 is risky (capital-intensive sectors like infra/power run higher)
- Current Ratio: 1.5 – 3 is healthy; below 1 signals liquidity stress; too high (> 3) can mean idle assets
- Interest Coverage Ratio: > 4-5x is safe; below 2x is a red flag
Growth
- Revenue Growth (3-5yr CAGR): > 10-15% annually is considered strong growth
- EPS Growth: Should track or exceed revenue growth — shows improving efficiency, not just top-line expansion
- Promoter Holding: > 50% generally shows strong commitment; rising trend is positive; falling or heavy pledging is a red flag
Cash Flow
- Operating Cash Flow: Should consistently be positive and roughly track or exceed net profit — if profit is high but OCF is low/negative, earnings quality is questionable
- Free Cash Flow: Positive and growing; negative FCF for a few years is only okay for high-growth/expansion-stage companies
Dividend
- Dividend Yield: 1-3% is typical for growth companies, higher (4%+) for mature/value stocks
- Payout Ratio: 20-50% is generally sustainable; > 70-80% may limit reinvestment in growth (except utilities/mature businesses)
Quick red-flag checklist
- Debt rising faster than revenue
- Net profit growing but operating cash flow flat/declining
- Promoter pledging shares increasing
- Frequent auditor resignations
- ROE/ROCE trending down over 3+ years
These are general guardrails, not fixed rules — capital-intensive sectors (infra, telecom, power) naturally run higher debt and lower margins than asset-light sectors (IT, FMCG), so always benchmark against industry peers, not just these numbers in isolation.
Balance Sheet & Ratio Analysis
A reference guide to key balance sheet terms and the financial ratios used to assess a company's health, illustrated with a worked example in Indian Rupees (₹).
1. Key Balance Sheet Terms
Assets — what the company owns
● Current Assets: Assets expected to be converted to cash within one year — cash, accounts receivable, inventory, prepaid expenses.
● Non-Current (Fixed) Assets: Long-term holdings such as property, plant & equipment, and intangible assets like patents or goodwill.
● Inventory: Goods held for sale or used in production.
● Accounts Receivable: Money owed to the company by its customers for goods or services already delivered.
Liabilities — what the company owes
● Current Liabilities: Obligations due within one year — accounts payable, short-term debt, accrued expenses.
● Non-Current Liabilities: Long-term obligations such as long-term debt, bonds payable, and deferred tax liabilities.
● Accounts Payable: Money the company owes to its suppliers.
Equity — the owners' stake
● Share Capital: Funds raised by the company through the issue of shares.
● Retained Earnings: Cumulative profits kept in the business rather than distributed as dividends.
● Reserves: Funds set aside from profits for specific future purposes.
Core identity: Assets = Liabilities + Equity
Balance Sheet Red Flags to Watch For
1. Debt-Related Warning Signs
- Debt-to-Equity ratio rising sharply year-on-year
- Short-term debt used to fund long-term assets (mismatch signals liquidity stress)
- Frequent new borrowings even when profits are reported as growing
- Interest coverage ratio falling below 2x
2. Liquidity Stress
- Current Ratio below 1 (current liabilities exceed current assets)
- Quick Ratio well below 1, especially alongside high inventory
- Cash & cash equivalents shrinking sharply quarter-on-quarter
3. Receivables & Inventory Red Flags
- Accounts Receivable growing much faster than Revenue — could mean sales are being “pushed” or not actually collected
- Inventory piling up faster than sales growth — may indicate unsold stock or demand slowdown
- Rising receivable days / inventory days over several quarters
4. Asset Quality Issues
- Large or unexplained “Other Assets” or “Miscellaneous Expenditure” — often used to hide losses
- Goodwill forming a very large % of total assets (from overpaying in acquisitions) — future write-down risk
- Frequent asset revaluations that boost book value without real cash backing
5. Equity Red Flags
- Repeated equity dilution (frequent new share issues) — dilutes existing shareholders without proportional growth
- Reserves declining or turning negative — signals accumulated losses eating into net worth
- Promoter shareholding falling steadily, especially combined with high pledging of shares
6. Contingent Liabilities
- Large contingent liabilities (mentioned in notes, not the main balance sheet) relative to net worth — pending litigation, guarantees, disputed taxes that could materialize into real liabilities
7. Related-Party Red Flags
- Large loans/advances to related parties or group companies — money leaving the business through non-transparent channels
- Unusual or opaque related-party transactions in the notes
8. General Structural Warning Signs
- Total Liabilities growing faster than Total Assets over time (deteriorating net worth)
- Negative working capital (Current Liabilities > Current Assets) persisting for multiple years
- Frequent changes in auditors or qualified/adverse audit opinions
Rule of thumb: one red flag in isolation may be explainable, but 2-3 appearing together (e.g., rising debt + rising receivables + falling promoter holding) is a strong signal to avoid or investigate deeply before investing.
