The balance sheet shows three things: assets (what company owns), liabilities (what it owes), and equity (what’s left for shareholders). The formula: Assets = Liabilities + Shareholders’ Equity. Everything must balance or the accounting’s wrong.
Most traders skip balance sheets thinking income statements matter more. Wrong. Income statements show profit on paper while balance sheets reveal whether the company actually holds cash.
What Gets Picked Up First
Current Ratio shows if the company covers short-term obligations. Current Assets divided by Current Liabilities should be above 1:1. If it’s 0.8:1, the business owes more than it has—a major red flag.
Debt-to-Equity Ratio reveals leverage. Calculate Total Liabilities divided by Shareholders’ Equity. Above 2:1 in most industries signals trouble. Companies carrying excessive debt struggle when interest rates rise.
Balance Sheet Equation: Assets = Liabilities + Shareholders’ Equity
Check cash flow. HDFC Bank showing ₹50,000 crore cash? Strong position. But if cash dropped ₹10,000 crore year-over-year with rising debt, that screams “burning cash”.
Red Flags That Kill Stock Picks
Inventory rising while sales stagnate? That’s dead stock piling up. Means customers aren’t buying and cash gets trapped.
Declining cash reserves quarter after quarter destroys picks. It’s like watching the fuel gauge hitting empty.
Balance Sheet Red Flags: Declining Cash, Rising Debt, Negative Equity
Negative working capital means short-term obligations exceed current assets. Current liabilities more than current assets? The business can’t breathe.
Rising liabilities without explanation signals desperation. Companies probably borrow to stay afloat instead of earning cash from operations.
Stock Picking Strategy
Compare balance sheets across 3 years—not snapshots. A strong balance sheet today means nothing if equity is declining every year. Asset-to-Liability ratio above 1 signals strength; below 1 screams vulnerability.
Find companies with high cash, low debt, stable equity growth. These rarely collapse. Tata Consultancy Services maintains ₹30,000+ crore cash with debt under ₹5,000 crore—fortress balance sheet.
Avoid value traps—stocks appearing cheap because balance sheets deteriorate. Just because a stock dropped 50% doesn’t mean it’s undervalued—check if the company’s bleeding cash, stacking debt, or equity turning negative.
Compare ratios to industry peers. Telecom companies typically carry higher debt than software firms—that’s normal. But if one telecom company’s debt doubles while competitors stay stable, investigate why.
Use balance sheet + income statement + cash flow statement together. One statement alone produces blind spots. Strong profit on income statement but declining cash + rising debt = trap waiting to snap.
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