Reading a balance sheet: assets, liabilities, equity and what they reveal

What you will learn

• The accounting equation and the main balance sheet items
• The difference between current and non-current items
• How to calculate book value per share, tangible book value and working capital
• Warning signs such as large goodwill or fast-rising receivables

Explanation

The balance sheet (statement of financial position; German: Bilanz) is a snapshot on one date, usually the last day of the financial year. The income statement is a film of a period; the balance sheet is a photo. It always satisfies the accounting equation:

Assets = Liabilities + Equity

Assets are resources the company controls that are expected to bring future benefits. Liabilities are obligations to others. Equity is the residual: what would be left for shareholders at book values.

Assets

• Current assets are expected to turn into cash within about 12 months: cash, trade receivables (money customers still owe), inventory (raw materials, goods in production, finished goods).
• Non-current assets: property, plant and equipment (PP&E), intangible assets such as software and patents, and goodwill. Goodwill appears when a company buys another company for more than the fair value of its identifiable net assets. It is not depreciated under IFRS but tested every year for impairment.

Liabilities and equity

• Current liabilities: due within about 12 months, for example trade payables (money owed to suppliers) and short-term debt.
• Non-current liabilities: long-term loans and bonds, pension provisions (common in Germany), lease liabilities.
• Equity: subscribed capital, capital reserves and retained earnings (past profits not paid out).

Key measures

• Book value per share = equity attributable to shareholders ÷ shares outstanding.
• Tangible book value = equity − goodwill − other intangible assets (in this lesson we deduct goodwill only, for simplicity).
• Working capital = current assets − current liabilities. Positive working capital means short-term assets cover short-term obligations.
• Equity ratio = equity ÷ total assets. It shows how much of the assets is financed by owners rather than creditors.

Book values are accounting values, mostly based on historical cost. A factory bought 30 years ago may be worth far more or less than its book value, and a strong brand built internally is usually not on the balance sheet at all. The balance sheet therefore tells you about financing and risk more than about what the company is "worth".

What to compare

Always compare at least two balance sheet dates. Useful questions: Are receivables growing much faster than revenue (customers paying later, or aggressive sales)? Is inventory piling up (weak demand)? Did goodwill jump (a large acquisition)? Is equity shrinking (losses, large buybacks or dividends)?

Worked example

Hypothetical example: Nordlicht AG at year end, € million, 50 million shares.

1. Check: assets €500m = liabilities €300m + equity €200m. ✔
2. Book value per share: €200m ÷ 50m = €4.00.
3. Tangible book value: €200m − €70m = €130m, or €130m ÷ 50m = €2.60 per share.
4. Working capital: €180m − €100m = €80m.
5. Equity ratio: €200m ÷ €500m = 40%.

Interpretation: 35% of equity (€70m of €200m) is goodwill. If that acquisition disappoints, an impairment would reduce equity directly.

Common mistake

Practice activity

Hypothetical: total assets €120m, total liabilities €84m, goodwill €15m, 12 million shares. Calculate equity, book value per share, tangible book value per share and the equity ratio.

Key takeaways

• Assets always equal liabilities plus equity; the balance sheet is a snapshot on one date.
• Book value is an accounting value, not a market value.
• Large goodwill and fast-growing receivables or inventory deserve a closer look.
• Compare several balance sheet dates to see the direction of change.

Next step

Next, you will read the cash flow statement and calculate free cash flow.