Intro to Financial Statements

Decoding Financial Statements

In this page, we look at two major financial statements of a company – the Balance Sheet and the Profit and Loss Account – and understand their different components.

Once we are done with these two statements we will look at 2-3 financial ratios that you ought to know so you can use these statements to your benefit. In the end, we will discuss qualitative factors that sometimes supersede these financial statements and ratios.

Since we are diving into a rather complicated field, we will try to keep things as simple as possible so it is easy to understand.

The Balance Sheet

The balance sheet represents the assets and liabilities of a company on a specific date. This is usually the end of the financial year for annual account statements and the end of the financial quarters for quarterly results. In India, the end of the fiscal year is taken as March 31, and the four quarters in the year are:

  • First Quarter: April 1 – June 30
  • Second Quarter: July 1 – September 30
  • Third Quarter: October 1 – December 31
  • Fourth Quarter: January 1 – March 31

The balance sheet consists of two parts: the Assets side and the Liabilities side. The Liabilities side also consists of the Equity Share Capital of the company.

This is because:

Shareholder Equity = Total Assets – Total Liabilities, which implies

Total Assets = Shareholder Equity + Total Liabilities

Let us talk about the different categories (called line items) in the example below for Hero Motors.

The Assets Side

Non-Current Assets: These are assets that can’t be converted to cash easily and won’t be converted within the next year. Non-current assets include both tangible and intangible assets.

  • Property, Plant and Equipment: This is a tangible asset section and includes items such as Property, Machinery and Equipment like Computers and Printers
  • Capital Work-in-Progress: These reflect the costs on fixed assets which are under construction as of the balance sheet date. This is again a tangible asset
  • Intangible Assets: These are is non-physical assets such as Goodwill, Brand Value and Intellectual Property, such as Patents, Trademarks, and Copyrights
  • Intangible Assets under Development: These reflect the cost of development of non-physical assets that are not as yet assets that can be monetised
  • Financial Assets: These are long-term financial assets of a company. These are again intangible assets
    • Investments: These can be bank deposits, bonds and stocks
    • Loans: These are loans advanced by the company and which will be repaid by the borrower. These can be loans to employees
  • Income Tax Assets: This reflects the advance income tax paid by the company minus any provision for taxation
  • Other Non-Current Assets: These include assets that cannot be classified under the above heads and can include Capital Advances, Prepaid Expenses and any balance with the government for Excise Duty or GST already paid

Current Assets: These are assets that are likely to be consumed, used or sold in the normal course business operations within the current fiscal year or operating cycle

  • Inventories: These reflect items that are ready for sale and raw materials that are used to produce the items that are available for sale. Examples include Raw Materials, Work-in-Progress Goods, Finished Goods, Manufacturing and Packaging Supplies, and Stores and Spares
  • Financial Assets: These are financial assets used by the company in the course of its business and are readily accessible or convertible into cash
    • Investments: These are investments in equity shares, preference shares, debentures, bonds and mutual funds
    • Trade Receivables: This line item reflects the amount that is owed to the company by buyers of its goods or services. The full payment is must be expected within one year
    • Cash and Cash Equivalents: These assets include cash or marketable securities that can be converted into cash immediately
    • Other Bank Balances: These are bank balance the company has kept aside for payment of dividend or other expenses
    • Loans: These are short-term loans that the company may have given or security deposits and which will be repaid or withdrawable within the year or operating cycle
    • Others: This shows the current financial assets that cannot be classified under any of the above line items. Examples may include Interest Accrued on Deposits, Accrual of Incentive from the Government and so on.
  • Other Current Assets: These are non-financial current assets that cannot be covered under any of the other line items and include Net Value of Leasehold Land, Prepaid Expenses, and Advances to Suppliers, among others.

The Liabilities Side

Non-Current Liabilities: As thename suggests, these are long-term liabilities of the company

  • Provisions: This line item shows the present liabilities and includes provisions for expenses such as Employee Benefits and Warranties for items sold
  • Deferred Tax Liabilities: This a tax liability that will have to be paid in the future for a transaction that took place during the current period

Current Liabilities: These areliabilities that will have to be settled or paid off within the fiscal year or current operating cycle

  • Financial Liabilities: These are short-term financial obligations that will have to be paid in the current fiscal or operating cycle
    • Trade Payables: These are payments that are owed by a company to its vendors and need to be paid in the current fiscal or operating cycle. These are for expenses directly related to the business of the company
    • Other Financial Liabilities: These are other short-term financial liabilities and may include Unclaimed Dividend, Creditors, etc.
  • Other Current Liabilities: These are other non-financial current liabilities and include Advances Received From Customers, Provident Fund or Employee State Insurance Contributions, and so on
  • Provisions: Here the provisions may be made for Employee Benefits, Warranties due in the current fiscal and so on

Equity: This reflects the total equity of the company and its reserves and surpluses

  • Equity Share Capital: This represents the total fully paid-up equity share capital of the company
  • Other Equity: Also, called Reserves and Surplus, this includes items such as the company’s Capital Reserves, General Reserves, Securities Premium, and balance of its Profit and Loss Account

Profit and Loss Account or Income Statement

The profit and loss account is the income statement of the company for a specified financial period. It shows the financial income and expenses over the course of the period. This is usually the financial year for annual account statements and the last financial quarter for quarterly statements.

The profit and loss account consists of two parts: Income and Expenses. Subtracting the Expenses from the Income gives the Profit before Tax. Deducting the Tax and adjusting for other related expenses gives the Net Profit, which in turn after division by the total outstanding shares of the company gives the Earnings Per Share (EPS).

Let us look of the different line items in the example below for Hero Motors.


  • Revenue from Operations: This is the income of the company from its core operations. It includes Sales from Products and Spare Parts, Income from Services such as Dealers Support Services, Drawback Received on Duty Paid, Incentive from State Government and Other Miscellaneous Income, among others.
  • Other Income: This line item includes Interest Income from Financial Assets, Dividend Income, Profit on Sale of Investments, Profit on Sale of Property, Plant and Equipment and so on.


  • Cost of Raw Materials Consumed: This includes the cost incurred on raw materials consumed in production
  • Change in Inventories of Finished Goods and Work-in-Progress: This reflects the difference between the stocks that were with the company at the start of the period (Opening Stock) and end of the period (Closing Stock) for which the income statement has been prepared
  • Excise Duty on Sale of Goods: As the name suggests, this is the Goods and Services Tax a business has to pay
  • Employee Benefit Expenses: This includes all expenses related to employees such as Salaries, Contribution to provident and Other Funds, Employee Stock Compensation, Staff Welfare Expenses, and so on
  • Finance Costs: These costs include Interest Expenses such as interest paid on security deposits made by dealers, etc.
  • Depreciation and Amortisation Expenses: These are reduction in value of the equipment used as well as periodic write-offs of larger expenses spread over a few months or years. These reductions are for Buildings, Plant and Equipment, Furniture and Fixtures, Vehicles, Office Equipment, and so on
  • Other Expenses: These are the expenses that are not covered under any other line items and include expenses on Packing, Forwarding, Freight, value of Stores and Tools Consumed, Rent paid, Repairs and Maintenance costs, Insurance Charges, Advertisement and Publicity costs, and so on

Profit Before Tax: This is the profit after deducting the expenses from the income

Tax Expense

  • Current Tax: This is the total of all income taxes paid in the current year
  • Deferred Tax: This is the total of provisions made for income taxes to be paid in the future for the current year

Other Comprehensive Income: This includes revenues, expenses, gains and losses that are not recognised as a part of the profit and loss account. Examples may include unrealized gain or loss on bonds or investments, gains or losses from fluctuations of foreign currency against the rupee, and pension plans gain or losses, among others

Profit After Tax: This is the actual profit of the company

EPS: The earning per share is a key metric used to value a company. It indicates how much money a company makes for each share of its stock and therefore gives a comparable figure across companies of the same industry or different industries.

Financial Ratios

Financial ratios form an integral part of any investor’s arsenal to value a company.

The ratio gives a unique number for each company that is comparable to other companies across the industry and even across different industries.

If you are planning to buy shares but cannot decide which one is a better investment then looking at these ratios will help you decide:

  • Which company is offering better returns in an industry?
  • Which industry performs better on specific ratios?

In this section, we look at 6 key financial ratios that will help you make better decisions.

Earnings per Share (EPS)

EPS measures the net profit earned on each share of a company’s common stock. You divide a company’s net profit or income by the weighted average number of ordinary equity shares outstanding over a certain period of time to arrive at this number.

If a company has zero earnings or a loss (negative earnings), then the earnings per share will also be zero or negative.

Financial experts also calculate something called the Diluted EPS which not only considers the weighted average number of ordinary equity shares outstanding but also outstanding options, convertible securities and warrants that are likely to affect the total share count.

Price-Earnings (P/E) Ratio

This is the most common indicator of a company’s performance. It shows the expectations of the market and is the price you pay per unit of its earnings.

It is calculated by dividing the Share Price by the Earnings Per Share. It can also be calculated by dividing the Company’s Market Capitalisation by its Net Profit.

A high P/E indicates a risky investment as the share may be overvalued. A low P/E indicates a value stock. Different industries have different P/E ratio ranges that are considered normal for their industry.

Return on Equity (ROE)

ROE measures the returns the shareholders are getting from a company and is a good indicator of the efficiency of its business operations. It is calculated by dividing the net profit by the equity capital.

Like the EPS and P/E ratios, the ROE is also used to compare a company to its competitors and the overall market, and like the two earlier ratios, ROE is specific to an industry.

A continuous rise in the ROE is an indicator that the company is able to utilise its funds efficiently. If this is number is higher than the average number for the industry, then investors consider this a good sign.

Debt-Equity Ratio

The ratio shows the relative proportion of shareholders’ equity and debt used to finance a company’s assets. It indicates the extent to which a company’s capital structure is skewed toward debt or equity financing.

The debt-to-equity (D/E) ratio is calculated by taking the total debt and dividing it by the book value of the shareholders’ equity.

Like the other ratios discussed so far, this ratio should be seen in comparison with the overall industry and not on its own.

Working Capital Ratio (or Current Ratio)

This ratio measures the company’s efficiency and the health of its short-term finances. It checks the firm’s ability to pay off its current liabilities with its current assets.

The formula to determine working capital is the company’s current assets divided by its current liabilities.

A company should have a current ratio of more than 1. Ideally, the ratio should be a minimum of 1.5 but preferably not more than 3. Having a current ratio above 3 is a good indicator that the management does not use the company cash efficiently.

Quick Ratio (or Acid-Test Ratio)

The Quick Ratio shows how well the current liabilities are covered by cash and other current assets that have a ready cash value. It indicates the short-term liquidity position and measures a company’s ability to meet its short-term obligations with its most liquid assets.

The quick ratio is calculated by subtracting the inventories for a financial period from the current assets of that period and dividing this number by the current liabilities for the same period.

Changes in inventory usually cause the biggest difference between current and quick ratios. The quick ratio measures the immediate resources of a company against all of its current liabilities. As such, it is a more conservative measurement than the current ratio.

A quick ratio should always be more than 1. The higher the ratio, the greater is the company’s liquidity.

Beyond the Numbers

When you look at a company and analyse its financials, you may tend to overlook certain key components that affect future business performance.

For instance, the company we picked to show the financials was Hero Motors. In June 2023, the Indian Ministry of Corporate Affairs (MCA) ordered an investigation to assess the company’s relationship with a third-party vendor in a case related to alleged diversion of funds.
This was not something you would have gathered from skimming the company’s financials and no equity research report from any AMC reported this in any of their research reports, meaning they missed it too.
Also, the company’s share price despite a few falls in its bullish upswing continued to rise in the months ahead. Perhaps, the size of the company (FY2022-23 revenue of ₹33,805.65 crore) vis-à-vis size of the alleged tax evasion (₹16 crore) has something to do with it.

However, sometimes some of these aspects become more critical than the financials. These are the macroeconomic and socio-political trends and the qualitative factors that determine a company’s future.

A good example of a major macroeconomic trend was the COVID-19 pandemic.  

Also, looking at the management and knowing how they work is a good indicator of whether a company will succeed or fail. There are innumerable cases of when the CEO of a company drove it ahead of its industry peers, and also of instances when the top management pulled a business down from its glory heights due to mismanagement.  

Unfortunately, these types of qualitative information often go unreported and most investors do not know about them. But if you keep track of the industry and increase your domain knowledge, then you will be able to see the signals and understand which businesses are better than their peers. This insight will take time to develop and will only develop if you keep at it and not otherwise.

But there is an easy way to do this if you are just starting out in the world of equity investing.

And the easy way to understand which companies are better is to track the top mutual funds across different categories and see which companies they have in their portfolio – which are the ones they have added and which are the ones they have removed.

The top fund managers have years of experience and keep a close watch on the market. They may not be able to predict everything but they will be able to foresee most happenings and changes in the industry.

The final idea then is to look at both aspects – financial and non-financial – and make smarter decisions while investing.