This document is an addition to the video I made on balance sheets and how to read and

understand them better. In this document I highlight the key things I look for and how I use them
to come to conclusions on the financial health of a company. I hope this content can help you
learn something new, and become a better investor. Now let’s get into it.

Step #1 - Current Ratio

The first thing I like to do whenever I am taking a look at a balance sheet is look at the current
ratio. The current ratio shows investors how much assets the company has that are easily
liquidated into cash vs. the liabilities/debts that are due within the next 12 months. The higher
the current ratio, the better the financial position of the company.

Many investors like to see the current ratio above 1, because it means the company has more
assets than liabilities due within the next year. Or in other words, the company should be able to
handle all of its debts within the next 12 months.

The current ratio is calculated by taking the current assets and dividing them by the current
liabilities. Let’s look at GOOG as an example.

GOOG has $188,143,000 in current assets and $64,254,000 in current liabilities. So GOOG has
$64,254,000 in debt that it needs to pay within the next year, and it has $188,143,000 in current
assets that can be easily converted to cash to deal with them.
If we find the current ratio, which is $188,143,000 / $64,254,000 we get 2.93. This means that
GOOG has 2.93X the current assets as current liabilities, or in other words, has more than
enough assets to pay off debts in the next year. In conclusion, we can say that GOOG isn’t in
any financial stress and should be safe from bankruptcy or anything like that. GOOG is in a very
strong financial position.

Now let’s take a look at another example, and this time let's look at PPL.TO.

Here we can see that PPL.TO has current assets of $1,245,000 and current liabilities of
$2,390,000. This right away tells me that PPL.TO has more current liabilities than current
assets, or in other words, PPL.TO does not have enough current assets to deal with all its debts
in the next year.

Let’s find the current ratio. $1,245,000 / $2,390,000 = .52. Since the current ratio is below 1, it
means that PPL.TO does not have enough assets to pay its liabilities that are due within the
next year.

An investor could look at this and conclude that PPL.TO does not have the strongest balance
sheet, and if this business stopped making money today, it wouldn’t be able to handle all of its
debts that are due within the next year.

In this situation where the company has a low current ratio, the investors are relying on the
company’s ability to produce cash flow to continue paying off debt and operating. So when I see
a company has a low current ratio, I immediately head to the cash flow statement and see if the
company is producing positive cash flow. If the company isn’t, then I ask myself “how is this
company going to pay off its debts when it’s not producing any money?” The answer is through
dilution, or raising more money through even more debt. Both are bad.

In PPL.TO’s case, we can see they produced $1,992,000 of free cash flow in the past 12
months.

$1,992,000 of free cash flow + $1,245,000 of current assets = $3,237,000, which is more than
the current liabilities. This essentially means PPL.TO should have enough cash flow to continue
paying debts.

But I am getting ahead of myself. This is a balance sheet document, right? We aren’t on cash
flow yet, but you can already see how these financial documents can be used together to come
to conclusions and avoid bad investments.
Step #2 - Net Asset/Book Value Growth

The next thing I take a look at is the company’s net asset or book value growth. This metric
shows you if the assets are growing faster than the liabilities, or if the liabilities are growing
faster than the assets. Typically investors prefer companies that have a history of growing the
book value, because it means the company is essentially growing the amount of assets it has.

GOOG is just such a beautiful example of this.

Here we can clearly see that over the past 19 years, GOOG has been consistently growing its
book value. I see this as a good thing because it means that the company has been able to
continually grow its assets at a much faster rate than it takes on liabilities.

Now there is a caveat here, because book value can be increasing due to the company doing
an acquisition and taking on a lot of goodwill and intangible assets. Warren Buffett calls these
“phony assets” because they essentially have no real, tangible value.

TDOC is a good example of this.

On the chart above we can see that TDOCs book value spiked massively. Typically when I see
this it suggests that the company did an acquisition and most likely added a ton of goodwill and
intangible assets to the balance sheet.

If we take a look at TDOCs goodwill and intangible assets chart, we see the following.

We can clearly see that TDOCs goodwill and intangible assets spiked at the same time as the
book value, which confirms that TDOCs book value spike was due to goodwill and intangibles,
which means TDOC did a massive acquisition and in the process, gained a ton of goodwill and
intangibles.

What I do in conjunction with checking the book value growth to help get a better understanding,
is check the tangible book value growth. The tangible book value removes goodwill and
intangibles from the assets in the calculation, and shows investors the book value of the
company’s tangible assets.
Let’s look at TDOCs tangible book value.

Here we can see that TDOCs tangible book value is actually negative, which essentially means
that if we remove the goodwill and intangible assets from the balance sheet, then TDOC has
more liabilities than tangible assets. Again, this is why it is important to check the tangible book
value as well, and see if there are large discrepancies between the tangible book value and
book value.

Let’s take a look at GOOGs tangible book value growth now.

Here we can see that GOOGs tangible book value growth looks very similar to their book value
growth, which to me is a good sign. GOOG does do acquisitions and has goodwill and
intangibles on its balance sheet, but the company is still managing to grow its tangible book
value very nicely and consistently.

The last thing we need to cover is what declining book value can suggest. Let’s look at BYND as
an example.
As we can see, BYND is seeing its book value decline. This can suggest that the company is
growing its liabilities faster than its assets, and/or that the company is unprofitable and burning
cash. But typically if the book value is consistently going down, then it means the company is
losing money.

Here we can see that BYND produced -$437,331 in free cash flow in the last 12 months, which
confirms that the company is burning money. You know what, BYND is a great segway into our
next step, but first let’s recap the main takeaways.

Main Takeaways:

1. I look for net asset/book value growth

2. Spikes in book value suggest the company did an acquisition
3. Check tangible book value growth in conjunction with book value
4. Book value declining suggests the company is losing money or taking on debt
Step #3 - Look at cash growth

Alright, back to BYND. Let’s look at its cash position over time.

Here we can see that BYNDs cash position increased by roughly $1,000,000 in one quarter.
However, we can then see the cash has been going down ever since the increase. Let’s look at
Stock Unlocks bar graph to see this another way.

We can clearly see that that BYND has this trend of cash spiking, then going down, then
spiking, then going back down. It’s very interesting, right? Now why could this be happening? I
mean, if a company is increasing its cash then that’s a good thing, right?

Well, remember from earlier that BYNDs book value is decreasing. This means that BYNDs net
asset value is decreasing at the same time as the cash (and total assets) are increasing. How
does this happen? Because BYND is taking on debt. This cash/asset increase is because the
company took out a massive loan.
Let’s take a look at BYNDs long term debt.

Long term debt spiked at the same time as cash and assets. This suggests that BYNDs cash
increase again was from taking on long term debt. Now what’s important to note is that BYNDs
cash position spiked, but is now coming back down, as we saw earlier. This is because BYND is
burning cash, as we saw from the cash flow statement.

Essentially what’s happening to BYND is the company takes on debt or dilutes, burns the cash,
then takes on more debt or dilutes. By checking the cash position and the book value, we could
spot clues to this. Investors could conclude that this is a more risky company because it’s taking
on debt to keep the lights on while the company burns hundreds of millions of dollars. This is a
recipe that can’t last forever, and it’s suggesting that the company is leveraging up its balance
sheet to stay afloat. Fun times.

Now, let’s look at our beautiful GOOGs cash growth for a nice contrasting comparison.

My goodness. Would you just look at it. Beautiful. Over time GOOG has been able to increase
its cash position organically, while also growing its tangible book value. This suggests once
again that GOOG is growing its cash position organically without taking on debt. In fact, GOOG
has more cash than total liabilities.
This means the company could use its current cash position to become 100% debt free. It’s in a
very good position financially.

Summary

That pretty much wraps up the main things I look for on a balance sheet. There is more to
consider like long term debt growth etc. but these 3 steps should put you in a good position to
start understanding balance sheets more, and see trends in companies balance sheets.

The balance sheet is meant to show investors the financial health of a company, which in my
opinion is one of the most important things to consider when investing. You can clearly see
which companies are financially sound, and which ones are losing money, as well as growing
their asset value.

It’s incredibly important to understand balance sheets, because they can help you avoid some
seriously bad companies, and investments. I know some investors who will not touch
companies if they don’t have a current ratio above 1. But it all depends on the individual's risk
tolerance. Personally I will own companies with current ratios below 1 as long as they’re
producing cash flow.

What’s important is being able to know and understand the risk you’re taking on with every
investment you make. Knowing how to read balance sheets and what to look for will help you
understand the risk better, and more accurately gauge the risk you’re taking on.