Read Balance Sheet in 3 Simple Steps!

Ashutosh , Last updated: 26 November 2014
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If you have been studying Business, Finance, Economics then chances are that you are going to work in these domains. You definitely need to know some basic principles in order to understand & manage the finances better. During an interview for these jobs, a question that pops up often is: Can you read a balance sheet

A lot of times, you have to write an analytical commentary on historical financial performance of the business. So, those aiming-to-be Equity Research analysts, Investment Bankers, Project Financiers, Finance Managers, Chief Financial Officers: don t miss out on this skill!

A Balance Sheet is comprised of equity and liabilities (i.e. Sources of Funds) and assets (i.e. Use of Funds). The source of funds can be equity, debt or the current liabilities, whereas the Use of funds may be in the form of assets, fixed and current assets. The current assets are basically those assets that are going to be realized in a short period of time, within 1 year. On the other hand, the fixed assets are those which keep giving you economic benefits for more than a year. The balance sheet is always drawn up at a certain point in time.

Although it may seem a little daunting at first, you can read the balance sheet and draw some important insights in just 3 steps!

Check this video:

1. COMPOSITION: Understanding the Composition of various groups i.e. What are Sources of funds comprised of What are assets comprised of Do more of fixed assets or more of current assets make up the asset side Are there any losses

2. COMPARISON: Comparing two or more balance sheets i.e. Changes in the Closing Balance Sheet (drawn at year-end) vis- -vis Opening Balance Sheet (drawn at the beginning of the year). For example, this can be used to check if a type of assets has grown or shrunk over a period of time. Sometimes you may also compare Balance Sheets as on a particular date for two or more companies.

3. RELATIONSHIPS: You can draw relationships by calculating ratios. For example, calculating the ratio of Debt to Equity (financial leverage ratio). Or Finding a relationship between short term assets and short term liabilities (Current Ratio). In advanced levels of this step, there are many relationships that we draw between an element of the Balance Sheet and another element from the Profit & Loss Account (Income Statement). For example a ratio of Net Profit and Equity to find out how much return the company managed to deliver on equity shareholders, funds during a particular year. This ratio is known as Return on Equity.

For learning how to read historical financials and preparing financial projections using MS Excel, do consider signing up for our specialized program here.

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Ashutosh
(Finance Professional)
Category Students Report

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05 December 2014 Danish Maqusood

Thnx good steps perpaing B/S

27 November 2014 Ashutosh

3. RELATIONSHIPS: Lastly, analysing relationships i.e. Relationship of one item on the Balance Sheet with another item. Let’s try and understand the Debt to Equity Ratio of Fortis Healthcare (Consolidated). Check how it was almost 3:1 in FY10, came down to 2:1 in FY12 and finally to 0.40:1 in FY14. There are two reasons for the same. The equity has gone up and the debt has reduced i.e. the denominator has gone up and numerator has reduced. You can now understand how debt has come down. Is it that the debt has been repaid? Does it have any connection to the scale of the business etc.? Similarly, you may want to understand the relationship of long term funds with long term assets. Or short term funds with short term assets. Or to what extent do fixed assets cover the long term debt in the business etc. You can go few steps ahead to understand the relationships between an item on the Balance Sheet and that from Profit & Loss Account.

27 November 2014 Ashutosh

2. COMPARISON: Here, compare how the items are changing year on year and understand the reasons. For example, Equity. You can notice that the Equity has increased from Rs. 1,887 crore as on FY2010 to Rs. 4,282 crore as on FY2014. What are the reasons? 1. Look at reserves: They have gone up from Rs. 1,191 crore as on FY 2010 to Rs. 3,820 crore. Understand if retained profits are the only reason or Securities Premium (an issue of shares) is driving this increase. Also note that the comparison can now give you the answer to why preference share application money lies there in FY14. It is almost same amount, which was lying in the form of Preference Capital earlier. It is possible that these Preference Shares may have been redeemed recently and the company has issued new preference shares again. It needs to be understood whether they have been issued to the same investors or not. A comparison of Fixed Assets year-on-year can help you understand whether the company has done a big capital expenditure or acquisition or even sale of business division. Check Fortis example again: Fixed Asset gross block increased from Rs. 3,016 crore in FY11 to Rs. 10,143 crore. Analyse the reason for the same. Is it an acquisition? Note that the gross block has reduced to Rs. 5,002 crore from Rs. 10,166 crore. Is it because they sold some business division or large asset? Or is it because there was a large impairment? Basically, the comparison gives you some more clues to understand how the business events and performance may have affected the Financial position of the company. These insights are very critical for business analysts and investors. (CONTD...)

27 November 2014 Ashutosh

STEP 1 IN OUR EXAMPLE: 1. COMPOSITION: Analyze the composition of Equity, Liabilities or Assets. You can look at Equity for example. As on March 31, 2014, it was Rs. 4,282 crore. It was comprised of Equity Share Capital, Pref Share Application Money, Reserves and Surplus. Now, you may have to probe the Pref Share Application Money further. You will have to analyse what are reserves made up of, are there any revaluation reserves, any free reserves etc. Similarly you will have to analyse the composition of Asset side. Are there more fixed assets, or current assets. This may be driven by the stage of the business, the business model or even the industry in which the company operates. For example, a hospital owing-operating company (like Fortis) may have fixed assets as the main component of the asset side, whereas a Services company could be asset light i.e. It may have more of Current Assets (in the form of Work in Progress, Receivables, Cash) rather than heavy fixed assets. You may also analyse the composition of current assets further to understand whether it consists of more inventory (could be slow-moving or fast-moving), debtors or cash! So, in short analyse the composition and go deeper to understand the reasons / drivers. (CONTD...)

27 November 2014 Ashutosh

Jinal Sheth, These steps are to get a direction to your analysis. For example, check a the Consolidated Balance Sheet of any listed company. Lets take Fortis Healthcare. Check this link: http://www.moneycontrol.com/financials/fortishealth/consolidated-balance-sheet/FH

27 November 2014 Jinal Sheth

Kindly elaborate with example.....

27 November 2014 Sumit

very informative article....i come from a non-finance background...& understanding the information was really easy... the attached video was a huge plus point...especially for the non-finance backgound people