How To Read a Balance Sheet As An Investor: The 7 Questions Prudent Investors Need to Ask!

Knowing how to read a balance sheet is a key skill investors need to know, because the balance sheet is the most underrated document in an annual report. Most new investors skip straight to earnings – perhaps not knowing how importance the balance sheet is or having an appreciate but not knowing how to read it. Either way, neglacting it is a mistake. Here is how to read one properly, using Wesfarmers as a live example.

What the Balance Sheet Actually Is

The best analogy to use is that of a financial photograph — the balance sheet captures the exact state of a company’s finances on a single day. Unlike the income statement, which tells you how much money a company made over a period, or the cash flow statement, which tracks where money moved, the balance sheet answers one fundamental question: what does this company own, what does it owe, and what is left over for shareholders?

The structure is always the same. On one side, you have assets — everything the company owns or is owed. On the other, liabilities — everything the company owes to someone else. The difference between the two is equity, also called shareholders’ funds or net assets. The equation never changes: Assets = Liabilities + Equity. If these do not balance, something is wrong with the accounts.

That simplicity is deceptive. Within those three categories sits a great deal of information that distinguishes a financially strong business from one quietly accumulating risk.

The Wesfarmers Balance Sheet at a Glance — FY25

Wesfarmers is Australia’s largest conglomerate retailer, operating Bunnings, Kmart, Target, Officeworks, and a growing industrial and health division. It is one of the most widely held stocks on the ASX. As at 30 June 2025, its balance sheet read as follows:

That equity growth from A$8.58bn to A$9.19bn is a positive signal — the company is retaining value. But the headline numbers only tell part of the story.

Assets: Look Past the Total

Assets split into two categories: current assets (things that can be converted to cash within 12 months — inventory, receivables, cash) and non-current assets (long-term holdings — property, equipment, goodwill, brand intangibles).

For Wesfarmers, current assets came in at approximately A$9.6bn. The most important line within that is inventory. As a retailer, Wesfarmers carries enormous stock across Bunnings and Kmart. Inventory that is growing faster than revenue can indicate poor sell-through, overstocking, or pricing pressure — all of which can foreshadow margin compression. Conversely, lean inventory relative to sales growth suggests strong operational execution.

The A$487m icash balance s notably lower than A$835m the prior year. That alone is not a red flag — cash can fall because the company is investing, paying dividends, or repaying debt. But you should always ask why it moved, not just how much it is.

The more instructive figure on the asset side is net tangible assets (NTA) — A$4.23bn against total equity of A$9.19bn. The gap between the two (~A$4.96bn) is the portion of equity that exists on paper but cannot be touched: goodwill and intangible assets.

The Assets That Matter More Than They Appear

The goodwill/intangibles section is where new investors most commonly get caught. Sometimes goodwill is its own line or it may just be part of intangibles more broadly. Goodwill arises when a company acquires another business for more than the book value of its assets, representing the premium paid for brand, customer relationships, or market position. Wesfarmers has carried significant goodwill for years, largely from its acquisition of Bunnings and Kmart. Intangible assets include brand values, software, licences, and similar non-physical items.

The critical discipline is to watch whether goodwill moves. If goodwill remains stable year-on-year, management is implicitly asserting that every acquisition was worth what was paid for it, a reasonable claim for Wesfarmers given Bunnings’ sustained dominance. But if goodwill suddenly falls, via an impairment charge; it means the company has written down the value of a prior acquisition. Impairments are often presented as non-cash and non-recurring. Treat that characterisation with scepticism. A goodwill impairment signals that management either overpaid for a business or that the business is performing below the assumptions made at acquisition. Either is informative.

Similarly, watch capitalised software and IT development assets. These have become increasingly large line items for retailers investing in digital platforms. Wesfarmers has been investing heavily in technology across OnePass, health, and data analytics. If software assets grow rapidly but the underlying businesses do not deliver corresponding revenue benefits within a reasonable time frame, those assets will eventually be written down. That write-down flows directly through the income statement as an impairment loss.

Provisions, which sit on the liabilities side, are also important to watch. You see, they represent management’s best estimate of future obligations that are probable but not yet certain — things like lease make-good costs, employee entitlements, legal claims, and restructuring costs. For Wesfarmers, provisions include long-service leave, annual leave, and store closure costs across its large retail footprint.

Provisions are where balance sheets can hide stress. A provision that grows meaningfully year-on-year without a clear operational explanation may indicate rising legal liability, customer refund obligations, or deteriorating employee tenure — all worth investigating. Conversely, a provision that shrinks unexpectedly can flatter reported equity and earnings, as unused provisions are reversed through the income statement as income. Do you see where we are going here? We want investors to not treat provisions as static accounting noise. When they move, ask why.

Lease Liabilities

For a retailer like Wesfarmers, this is one of the largest liability lines on the balance sheet. Under AASB 16 (the Australian equivalent of IFRS 16), all operating leases must be recognised on-balance sheet. Wesfarmers reported capital lease obligations of A$6.45bn in FY2025. That is a number large enough to change your view of the company’s true leverage.

Many investors look at Wesfarmers’ A$4.2bn in financial debt and conclude its balance sheet is conservatively geared. Add A$6.45bn in lease obligations and the picture shifts materially. Total obligations against equity of A$9.19bn puts the company in a substantially different position than the headline debt-to-equity ratio of 47.2% implies. This does not mean Wesfarmers is over-leveraged: After all its EBIT of A$3.9bn and interest coverage of ~9.9x demonstrates comfortable servicing capacity. This being said, it illustrates why reading every line matters.

Liabilities and Equity: The Solvency Questions

The first solvency test is the current ratio: current assets divided by current liabilities. For Wesfarmers, current assets of A$9.6bn exceeded current liabilities of A$8.6bn — a current ratio of approximately 1.1x. This is tight by some standards, but normal for a large retailer that collects cash from customers before it pays suppliers. Negative working capital businesses like Bunnings can operate safely with current ratios near or below 1x because their cash cycle is self-funding.

The second test is the debt coverage question: can operating cash flow service the debt? Wesfarmers’ operating cash flow covers its total debt at over 100% — a clear positive.

On the equity side, watch retained earnings over time. If equity is growing primarily because the company is retaining profits and reinvesting them, that is a sign of a compounding business. If equity is growing only because the company is issuing new shares, that is dilutive and warrants scrutiny.

How To Read a Balance Sheet: A 7-Step Checklist

When examining a balance sheet, a useful 7-step framework is:

1. Is equity growing year-on-year? Wesfarmers: yes, A$8.58bn → A$9.19bn.
2. Is the current ratio above 1x, or is the business model self-funding? Wesfarmers: 1.1x, consistent with a retail model.
3. Is goodwill stable, or has it been impaired? Watch for impairment charges in the notes.
4. Are provisions moving in a direction that needs explanation? Always read the notes to the accounts.
5. What is the true debt load, including leases? A$10.65bn combined for Wesfarmers — far above headline financial debt.
6. Is interest coverage comfortable? Wesfarmers: ~9.9x — robust, in our view.
7. Is cash declining, and if so, why? A$487m vs A$835m prior year — given the drop, investors should investigate whether this is investment, dividends, or something else.

The Takeaway

The balance sheet does not tell you whether to buy a stock. It tells you whether you can trust what the income statement is saying. A company can report excellent earnings while quietly deteriorating on the balance sheet — through rising provisions, swelling goodwill from overpriced acquisitions, or lease obligations that accumulate over time.

Wesfarmers, on this reading, presents a generally sound financial position: growing equity, comfortable interest coverage, and a business model that generates sufficient operating cash to service all obligations. However, the gap between total equity and net tangible assets — A$4.96bn sitting in goodwill and intangibles; means investors are pricing in the durability of Bunnings and Kmart’s competitive position. If that position were ever to erode, the write-downs would be significant.

That is precisely the discipline a balance sheet demands. It forces you to ask not just how a company is performing today, but what assumptions underpin the numbers, and what unravels if those assumptions prove wrong.