Lesson 3 of 10
The balance sheet
What a balance sheet measures on one day, why retained earnings is not money, and which assets are missing from it entirely.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- A balance sheet is a photograph of what a company owned and owed on one day, and it always balances by construction.
- What counts as debt is a choice, so three published debt-to-equity ratios for one company usually differ, and none of them is wrong.
- A lease standard that took effect in 2019 put operating leases on the balance sheet, so asset and liability ratios can jump across it, most at lease-heavy companies.
Assets equal liabilities plus equity, an identity that holds because equity is defined as whatever is left over. What makes a balance sheet hard to read is not that arithmetic. It is that its categories are narrower than the words used for them.
Each side is split into current, turning into cash or falling due within a year, and non-current. Retained earnings, inside equity, is the running total of profit kept rather than paid out. It is not cash: the money was spent on the assets on the other side.
One balance sheet, three debt-to-equity ratios
- Long-term debt only0.60x
- Plus short-term borrowings, current portion and finance leases0.79x
- Plus operating leases too1.10x
What counts as debt
Short-term borrowings, the current portion of long-term debt, finance lease liabilities and operating lease liabilities can each be included in debt or left out, and the source rarely says which it did.
Compare two debt ratios only when both were built the same way, and where the construction is not stated, treat the figure as unverified.
The transition that breaks a ten-year history
ASC 842 put operating leases on the balance sheet for public companies' fiscal years beginning after 15 December 2018. Before it, an operating lease sat in a footnote as a schedule of future payments. After it, the same obligation is a right-of-use asset and a lease liability, split between current and non-current like any other. Total assets rose, total liabilities rose, and every ratio built on either is not comparable across that line, with nothing the company actually owed having changed.
A ten-year history crosses this line. Apple's current ratio, current assets divided by current liabilities, was 1.35 (Apple Inc. FY2016 10-K, accession 0001628280-16-020309 (opens in a new tab)) in fiscal 2016 and 0.89 (Apple Inc. FY2025 10-K, accession 0000320193-25-000079 (opens in a new tab)) in fiscal 2025. The ratio alone cannot say how much of that fall came from the standard. The lease note can: in fiscal 2025 the current operating lease liability was $1,579 million (Apple Inc. FY2025 10-K, accession 0000320193-25-000079) of $165,631 million (Apple Inc. FY2025 10-K, accession 0000320193-25-000079) of current liabilities, so without it the ratio would read 0.90 (Apple Inc. FY2025 10-K, accession 0000320193-25-000079). Nearly all of the fall came from elsewhere.
Bought against built
The balance sheet records what was paid for, not what is worth something. An internally developed brand or a research programme that succeeded does not appear, because it was expensed as it was spent. The same items appear when they are bought: an acquired brand is recorded as an intangible asset, and the rest of the premium over the fair value of net assets becomes goodwill. Under ASC 350, goodwill is not amortised, only tested for impairment. Buffett's 1983 appendix on goodwill draws the distinction this leaves. Accounting goodwill is the residue of a price paid in the past. Economic goodwill is the capacity to earn a high return on tangible assets, and only the first appears on any balance sheet.
Check yourself
A source states a company's debt-to-equity ratio without describing how debt was defined. What should you do?
- Assume it is long-term debt only
- Treat the figure as unverified until you know the definition
- Compare it directly with a similarly labelled ratio from another source
Show the answer
Answer: B.
Three defensible definitions of debt give three different ratios from the same balance sheet. Without knowing which was used, the number cannot be compared with anything.A company adopts ASC 842 for its operating leases, with no new borrowing. What happens to its balance sheet?
- Nothing changes
- Total assets and total liabilities both rise
- Only liabilities rise, not assets
Show the answer
Answer: B.
ASC 842 places a right-of-use asset and a matching lease liability on the balance sheet together, so both sides rise even though nothing about what the company owes has changed.Compared with an organic competitor of identical operations, a company grown mostly by acquisition tends to show what?
- A lower book value of assets
- A higher book value of assets and equity
- No difference, since acquisitions are expensed
Show the answer
Answer: B.
A price paid for a business becomes goodwill and intangible assets on the buyer's balance sheet. The same capability, built rather than bought, is mostly expensed as it is created and never appears.Sources
- ASC 842, Leases.
- ASC 350, Intangibles, Goodwill and Other.
- Berkshire Hathaway shareholder letter, 1983, goodwill appendix, on accounting goodwill against economic goodwill.
What this leaves out
- This lesson describes a classified balance sheet as presented by a US commercial or industrial company. Banks, insurers and real estate investment trusts do not present one this way.
- It does not cover how individual balances are measured. Inventory cost method, pension assumptions and deferred tax each follow rules disclosed in their own note, and each changes the figure materially.
- The Apple figures are ratios computed from the balance sheets filed for the fiscal years named. They are history, not a statement about the company today and not a view on any security.
- The worked example uses round invented numbers so the arithmetic can be checked by hand.