How to Read a Company Balance Sheet

At first glance, a balance sheet looks like a wall of numbers. In fact it follows a clear logic: one side shows what a company owns, the other how it has financed those assets. Once you understand this logic, a handful of key figures is enough to judge how soundly a business is set up. This article shows how a balance sheet is structured, which ratios can be derived from it and what matters when you read one.

A snapshot on the reporting date

The balance sheet sets a company’s assets against their financing on a particular day, the balance sheet date. This is often 31 December, but many companies have a financial year that differs from the calendar year. The two sides of the balance sheet are always equal, because every asset is financed either with the company’s own money or with borrowed money. The total of one side is called the balance sheet total.

Because the balance sheet depicts only a single day, it says nothing about developments on its own. Whether a company makes a profit is shown by the profit and loss account, which sets the income and expenses of an entire financial year against each other. Where the money actually came from and where it went is shown by the cash flow statement. Why profit and available cash are not the same thing is explained in the article Revenue Is Not Profit.

Under Section 264 of the German Commercial Code (Handelsgesetzbuch, HGB), the annual financial statements of a corporation (Kapitalgesellschaft) consist of the balance sheet, the profit and loss account and the notes. Capital-market-oriented companies that are not required to prepare consolidated financial statements add a cash flow statement and a statement of changes in equity. The notes deserve particular attention, because that is where the company explains how it arrived at its figures.

The assets side shows what a company owns

The assets side lists what the company owns, and its layout is prescribed by Section 266 HGB. Fixed assets include everything intended to serve the company over the long term: intangible assets such as software, licences or acquired goodwill, tangible assets such as land, buildings and machinery, and financial assets, for example shareholdings in other companies.

Current assets comprise items that turn over quickly in day-to-day business: inventories such as raw materials and finished goods, trade receivables, that is invoices to customers that have not yet been paid, securities and, finally, cash in hand and bank balances. The order reflects how close an item is to cash: the further down it appears, the faster it is usually available as a means of payment.

The other side shows the financing

The equity and liabilities side shows where the funds come from. Equity comes first: the subscribed capital, meaning the share capital of an AG or GmbH taken up by the shareholders, plus reserves, any profit or loss carried forward and the result for the year. Equity is available to the company with no fixed obligation to repay it, and it is the first to absorb losses.

Below it come provisions, for example for pensions or taxes, and liabilities, for instance to banks or suppliers. Together they make up the bulk of the debt capital. For any analysis it is important to know when these debts fall due. Information on remaining maturities can be found in the balance sheet itself or in the notes, and many companies summarise it in a schedule of liabilities.

Key ratios and their formulas

Ratios that describe stability and solvency can be calculated from the balance sheet items. The most common formulas are:

• Equity ratio = equity / balance sheet total × 100
• Debt-to-equity ratio = debt capital / equity
• Fixed asset coverage II = (equity + long-term debt capital) / fixed assets × 100
• Cash ratio (first-degree liquidity) = cash and cash equivalents / current liabilities × 100
• Quick ratio (second-degree liquidity) = (cash and cash equivalents + short-term receivables) / current liabilities × 100
• Working capital = current assets minus current liabilities

The equity ratio shows what proportion of the assets is financed with the company’s own money, while the debt-to-equity ratio sets borrowed funds against own funds. Fixed asset coverage follows the principle that assets tied up for the long term should also be financed for the long term. Liquidity ratios and working capital indicate whether short-term debts can be met from funds that are available in the short term.

An example with invented, round figures makes the formulas tangible. Assume a skilled trades business (Handwerksbetrieb) with a balance sheet total of 2 million euros. Its debt capital of 1.4 million euros consists of 900,000 euros in long-term funds, namely pension provisions and bank loans, and 500,000 euros in current liabilities. Its current assets comprise 300,000 euros of inventories, 350,000 euros of receivables and 150,000 euros in bank balances.

Balance sheet total	€2,000,000
Fixed assets / current assets	€1,200,000 / €800,000
Equity / debt capital	€600,000 / €1,400,000
Equity ratio	600,000 / 2,000,000 = 30 %
Debt-to-equity ratio	1,400,000 / 600,000 = around 2.3
Fixed asset coverage II	(600,000 + 900,000) / 1,200,000 = 125 %
Quick ratio (second-degree liquidity)	(150,000 + 350,000) / 500,000 = 100 %
Working capital	€800,000 minus €500,000 = €300,000

The invented business’s fixed assets are entirely financed over the long term, and its short-term debts are covered by bank balances and receivables. The cash ratio of 30 per cent, however, shows that it relies on customers paying on time. Whether an equity ratio of 30 per cent is high or low can only be judged by comparison with the sector.

Where to find balance sheets

In Germany, corporations such as the GmbH (private limited company) and the AG (public limited company) must disclose their annual financial statements. Under Section 325 HGB, they submit the documents electronically to the body that maintains the Company Register (Unternehmensregister), generally no later than one year after the balance sheet date. There, the financial statements are publicly accessible. Small corporations may prepare an abridged balance sheet that contains only the main items. Sole proprietorships and many partnerships, by contrast, do not have to publish their figures.

Listed companies also publish their figures in their annual report, usually in the investor relations section of their website. Domestic issuers must make their annual financial report publicly available no later than four months after the end of the financial year. Groups whose securities are admitted to trading on a regulated market prepare their consolidated financial statements in accordance with the International Financial Reporting Standards (IFRS), as required by an EU regulation and Section 315e HGB. In Germany, the single-entity financial statements of the parent company continue to follow the HGB.

What matters when reading

Ratios only become meaningful through comparison. A software company needs hardly any machinery and manages with few fixed assets, whereas an energy utility ties up a great deal of capital in plant. Rather than applying a rigid benchmark, it therefore makes more sense to compare a company with others in the same sector and with its own figures from previous years.

Then there are reporting date effects. Because the balance sheet shows a single day, payments received shortly before the reporting date or seasonally fluctuating inventories can shift the picture. A retailer with strong Christmas trading looks different at the end of December than in late summer. Looking at several years evens out such fluctuations.

Leasing is a special case. Under the international standard IFRS 16, lessees have recognised most leases since 2019 as a right-of-use asset on the assets side and as a lease liability on the other side. In HGB financial statements, by contrast, many leases do not appear on the balance sheet. Anyone comparing IFRS consolidated financial statements with HGB financial statements should be aware of this difference, because it can noticeably change the balance sheet total and the equity ratio.

A balance sheet ratio without a sector and prior-year comparison is a number without a yardstick.

A balance sheet does not answer every question, but it helps you ask the right ones: how much equity is there to cushion losses, do assets and financing match in terms of time, and is the cash available in the short term enough for short-term obligations? Together with the profit and loss account, the cash flow statement and the notes, this produces a reliable picture. Terms that remain unclear while you read are explained in the Business Glossary.

Frequently asked questions

What is the difference between the balance sheet and the profit and loss account?

The balance sheet is a stocktake on a reporting date: it shows assets, equity and debts. The profit and loss account, by contrast, records all the income and expenses of a financial year and uses them to determine the profit or loss. The two are linked, because the result for the year from the profit and loss account flows into equity on the balance sheet.

What equity ratio is considered good?

There is no universally valid figure. How much equity is appropriate depends heavily on the business model: companies with substantial fixed assets and fluctuating earnings generally need a larger buffer than those with stable, recurring income. A comparison with companies in the same sector and the trend over several years are therefore more meaningful than any rule of thumb.

Where can you find a company’s balance sheet?

In Germany, corporations such as GmbHs and AGs must disclose their annual financial statements, which can be accessed via the Company Register (Unternehmensregister). Small companies may publish an abridged balance sheet. Listed companies also make their annual reports available on their websites, usually in the investor relations section. Sole proprietorships and many partnerships, by contrast, do not have to publish their figures.

Why do HGB and IFRS financial statements differ?

The German Commercial Code traditionally emphasises the prudence principle and the protection of creditors, whereas IFRS focus more on the information investors need for their decisions. As a result, some items are recognised or measured differently, such as leases, which under IFRS 16 usually appear on the balance sheet. Comparisons between companies are therefore only meaningful if both report under the same set of rules.

Terms

Equity ratio

Equity as a percentage of the balance sheet total, a measure of a company’s financial independence.

Fixed asset coverage

Ratio showing the extent to which fixed assets are financed by equity, or additionally by long-term debt capital (Anlagendeckung in German).

Provisions

Items on the equity and liabilities side for uncertain obligations, for example for pensions or taxes, whose amount or timing is not yet precisely known.

To the business glossary

Sources

1. German Commercial Code (HGB), Section 266: Layout of the balance sheetBundesministerium der Justiz und für Verbraucherschutz
2. German Commercial Code (HGB), Section 264: Reporting requirement; exemptionBundesministerium der Justiz und für Verbraucherschutz
3. German Commercial Code (HGB), Section 315e: Consolidated financial statements in accordance with international accounting standardsBundesministerium der Justiz und für Verbraucherschutz
4. German Commercial Code (HGB), Section 325: DisclosureBundesministerium der Justiz und für Verbraucherschutz
5. Company Register, the central platform for company dataUnternehmensregister

balance sheetequity ratiohgbifrsannual financial statements

Image: illustration, created with AI.