Reading a Balance Sheet: Nine Signals That Appear Before the Crisis

A balance sheet accumulates every decision your business has made over several years, which is why structural problems appear there before they appear in profit. Below are nine signals I have seen repeatedly in company files, almost always visible a year or two before the crisis they precede.

What you are looking at

The balance sheet — now more often called the statement of financial position — is a photograph, not a film. It answers three questions: what do we own, how much of it belongs to others, and how much is genuinely ours.

Before any ratio work, run four checks: the statement date, comparability with the prior period, the presence of notes, and whether the figures are pre- or post-adjustment. A balance sheet drawn before year-end adjustments is not a basis for decisions.

Sign 1: Large shareholder and director current accounts

This is the first place I look. A heavy debit balance means company liquidity is sitting with individuals. The effect is twofold: working capital shrinks, and on audit undocumented drawings can be recharacterised as taxable amounts. The structural fix is in separating personal and company accounts.

Sign 2: Receivables growing faster than sales

If sales grew 20 percent and receivables grew 60 percent, the company is selling but not collecting. Compute days sales outstanding and plot it over three periods. A rising figure means you are extending interest-free credit. Age the balances by customer and provide against them accordingly.

Sign 3: Inventory build-up

Inventory is capital wearing the costume of an asset. Watch three things: rising days of inventory held, concentration in a few slow lines, and the absence of any write-down despite visibly old stock. Where there is no disciplined stocktake, the inventory figure is usually larger than reality.

Sign 4: Maturity mismatch

A pattern common in manufacturing: buying machinery with short-term facilities. The asset returns over ten years while the debt matures within one. On the balance sheet it appears as a current ratio below one alongside growing fixed assets.

Sign 5: Accumulated losses and the Article 141 threshold

Accumulated losses are not just a negative number in equity; they carry a statutory threshold. Under Article 141 of the amended Commercial Code, if losses erode more than half of share capital, the board must call an extraordinary general meeting to decide on dissolution or continuation, and capital must be adjusted if the company continues. Ignoring the duty carries legal risk for directors and directly affects bank credit assessments.

Sign 6: "Other" and suspense balances

Any balance sheet with material amounts under "other assets", "suspense accounts", "sundry prepayments" or "sundry creditors" is itself a warning. In my experience these headings collect items nobody has resolved: old cheques, unsettled advances, and balances carried from prior years.

Sign 7: Non-operating assets and revaluation surplus

When land, non-operating buildings or unrelated investments make up a large share of assets, return on assets becomes meaningless. Revaluation surplus is unrealised: it inflates equity without bringing in a single rial of cash. In inflationary periods the distortion is more severe still.

Sign 8: Heavy advances received

Advances bring cash but they are a liability, not revenue. Rapid growth in advances alongside flat inventory and capacity means the company has taken on obligations it cannot yet resource. In construction and made-to-order manufacturing this signal typically precedes a liquidity crunch.

Sign 9: Provisions that are missing

An absent item is also a signal. If the company has long-serving staff but a negligible end-of-service provision, or heavy aged receivables with no doubtful debt provision, or fully depreciated assets still in daily use with no useful-life review, then reported equity is higher than reality. Useful-life reviews belong in the year-end routine, not in a special project.

A seven-step reading routine

1. Check the basis: post-adjustment or not, audited or not.
2. Line up two or three periods; single-period analysis is not useful.
3. Build a common-size statement, expressing each line as a percentage of total assets, to see the mix shift.
4. Compute the five core ratios above and chart their trend.
5. Schedule every ambiguous balance, with an owner and a deadline for each.
6. Reconcile to cash: profit and asset growth must be consistent with the cash flow statement — see the cash flow statement.
7. Read the notes. Contingencies, litigation and pledged assets are disclosed only there, and they can change the picture completely.

Key takeaways

• The balance sheet accumulates past decisions; structural weakness shows there first.
• Shareholder current accounts, slowing receivables and stagnant inventory are the three most frequent signals.
• Accumulated losses carry a statutory threshold at half of share capital.
• Clean up "other" balances before analysing ratios; dirty data misleads.
• Missing provisions matter as much as suspicious balances, and they overstate equity.