Financial health: balance sheet, debt and FCF

Profit is not yet cash

Net income on the income statement is an accounting number. A company can report a profit and still run out of money: customers haven't paid yet, inventory is piling up in the warehouse or a large debt payment is coming due. "Profitable" companies have gone bankrupt simply because they ran out of cash.

So to the income statement from the Fundamental analysis basics lesson we add two more documents: the balance sheet and the cash flow statement. They answer three questions:

1. Can the company survive a hard year (liquidity)?
2. How heavy is the debt load (leverage)?
3. Does profit actually turn into cash (cash flow)?

These questions matter to traders too: a company with a weak balance sheet falls much deeper on bad news.

Balance sheet: what it owns, what it owes

The balance sheet is a photo of a single day. Its core equation always holds: assets = liabilities + equity. In other words, every dollar the company owns was bought either with borrowed money or with shareholders' money.

Nur Tech's balance sheet ($m):

Assets — $180m:

• Cash and short-term investments: $40m
• Receivables (customers haven't paid yet): $25m
• Inventory: $15m
• Property and equipment (buildings, equipment, servers): $70m
• Other assets (intangibles etc.): $30m

Liabilities — $80m:

• Current liabilities ($25m owed to suppliers, $15m accrued expenses): $40m
• Interest-bearing debt: $10m
• Other long-term liabilities: $30m

Shareholders' equity — $100m.

The chart shows who funds the $180m of assets: $100m is shareholders' equity, while interest-bearing debt is only $10m. That is a very conservative balance sheet.

Liquidity: can it pay the bills due soon?

The current ratio = current assets ÷ current liabilities. Nur Tech's current assets: cash $40m + receivables $25m + inventory $15m = $80m. Current liabilities are $40m. Ratio = 80 ÷ 40 = 2.0: for every $1 due within a year there is $2 of current assets.

Selling inventory takes time, so a stricter version is the quick ratio: (80 − 15) ÷ 40 ≈ 1.6.

A guide: around 1.5–2 is comfortable; below 1 — check why. There is an exception: subscription companies collect cash in advance (future service is recorded as a "deferred revenue" liability), so a ratio below 1 can be normal for them.

Leverage: how heavy is the debt?

We measure debt three ways:

• Debt-to-equity (D/E) = interest-bearing debt ÷ shareholders' equity. Nur Tech: $10m ÷ $100m = 0.1.
• Net debt = debt − cash. Nur Tech: $10m − $40m = −$30m, meaning the company has $30m more cash than debt ("net cash").
• Interest coverage = operating income ÷ interest expense. This is the most practical measure: how many times profit covers interest.

Nur Tech's operating income is $25m and its interest expense $0.5m — coverage of 50x. Company Y: $40m ÷ $10m = 4x: manageable, but a bad year will be felt. Company Z: $12m ÷ $8m = 1.5x: if operating income falls just 33% (to $8m), all of it goes to interest. In a recession companies like Z are the ones forced to issue new shares (dilution) or sell assets.