INF25703 · READING THE LANGUAGE OF BUSINESSSUMMER TERM · 2026
A FIELD GUIDE TO
Financial Statements
& the key ratios that read them
Three statements. Four families of ratios. One skill — turning raw numbers into a story about a real business.
ACME WIDGETS CO.BALANCE SHEET · 31 DEC 2025 · $ MILLIONS
ASSETS
Cash, receivables & inventory400
Factories & equipment600
TOTAL ASSETS$0
LIABILITIES & EQUITY
Liabilities (owed to others)600
Equity (owned by shareholders)400
TOTAL L + E$0
In balance ✓
THE BIG PICTUREINF25703 · FINANCIAL STATEMENTS & RATIOS
Three statements. One story.
Every public company on earth speaks the same language: three documents that, read together, say where the money came from, where it went, and what is left.
“If the three don’t agree, someone isn’t telling the truth.”
01
Balance Sheet
What we own and owe — at one frozen moment in time.
SNAPSHOT
02
Income Statement
What we earned and spent — across the whole year.
THE MOVIE
03
Cash Flow Statement
Actual cash in and out — the hardest statement to fake.
TRUTH SERUM
STATEMENT Nº 1 — THE BALANCE SHEETACME WIDGETS · 31 DEC 2025
The one equation that never breaks
ASSETS=LIABILITIES+EQUITY
what you own = what you owe + what is truly yours
ASSETS
$0
LIABILITIES + EQUITY
LIABILITIES $0EQUITY $0
ASSETS$M
Current assets400
Fixed assets600
TOTAL$0
LIAB. + EQUITY$M
Current liabilities200
Long-term debt400
Equity400
TOTAL$0
It balances by construction: every transaction touches two places. Double-entry bookkeeping — 500 years old and still undefeated.
STATEMENT Nº 2 — THE INCOME STATEMENTACME WIDGETS · FY2025 · $ MILLIONS
From the top line to the bottom line
1,200
REVENUE
−720
COGS
480
GROSS PROFIT
−240
OPEX
240
OP. INCOME
−40
INTEREST
−50
TAX
150
NET INCOME
NET PROFIT MARGIN
1501,200=0
12.5¢ of every revenue dollar survives the whole journey.
Accrual accounting: revenue is recorded when earned, expenses when incurred — not when cash actually moves. That gap is why we need statement Nº 3…
STATEMENT Nº 3 — THE CASH FLOW STATEMENTACME WIDGETS · FY2025 · $ MILLIONS
Profit is an opinion. Cash is a fact.
OPERATINGTHE ENGINE
+$0M
Cash from customers, minus cash paid to suppliers and staff.
Can the core business feed itself?
INVESTINGTHE BET
−$0M
Bought new machines and a warehouse — spending to grow.
Negative here is often good news.
FINANCINGTHE PROMISES
−$0M
Paid dividends to shareholders and repaid part of a loan.
Cash to — or from — the funders.
NET CHANGE IN CASH · FY2025+$0M
A company can report profits for years and still run out of cash. Growth eats cash.
A raw number is mute. A ratio gives it a point of comparison — four of them:
÷ REVENUE→A MARGIN
÷ ASSETS→A RETURN
vs LAST YEAR→A TREND
vs RIVALS→A BENCHMARK
Ratios are the vital signs on the monitor — a doctor’s dashboard for a business.
THE MAP — FOUR FAMILIES OF RATIOSINF25703 · FINANCIAL STATEMENTS & RATIOS
Four families. Four questions.
i
Liquidity
“Can we pay our bills this year?”
CURRENT RATIOQUICK RATIO
ii
Efficiency
“How hard do our assets work?”
INVENTORY T/ODSO
iii
Leverage
“How much is borrowed — and can we carry it?”
DEBT / EQUITYCOVERAGE
iv
Profitability
“Is all this effort actually worth it?”
MARGINSROEROA
Same company, four interrogations. Next: each family under the microscope.
FAMILY 01 — LIQUIDITYACME WIDGETS · FY2025
Can we pay our bills this year?
THE RUNWAY QUESTION
CURRENT RATIO
CURRENT ASSETSCURRENT LIABILITIES=400200=0
$2 of short-term assets for every $1 due within a year.
QUICK (“ACID-TEST”) RATIO
CURRENT ASSETS − INVENTORYCURRENT LIABILITIES=220200=0
Strips out inventory — the asset you can’t always sell in a hurry.
⚠ TOO HIGH ISN’T “SAFE” — A 6× RATIO MEANS CASH SITTING IDLE, EARNING NOTHING.
WHERE ACME SITS — LIQUIDITY SCALE
1.1× QUICK
2.0× CURRENT
<1 CAN’T PAY1–1.5 TIGHT1.5–3 COMFORTABLE
FAMILY 02 — EFFICIENCYACME WIDGETS · FY2025
How hard do our assets work?
THE SPEED QUESTION
INVENTORY TURNOVER
COGSAVG INVENTORY=720180=0 / yr
0TO SELL THROUGH
≈ 91 DAYS ON THE SHELFEvery $1 of stock is sold and replaced 4 times a year.
DAYS SALES OUTSTANDING (DSO)
RECEIVABLESREVENUE× 365 =1201,200× 365 ≈0 days
0TO COLLECT
≈ 37 DAYS TO GET PAIDOur credit terms say 30 days — customers are running 7 days late.
SOURCE TRAIL — WHERE THESE FOUR NUMBERS LIVEINCOME STATEMENT · A FLOW · FY2025BALANCE SHEET · A SNAPSHOT · 31 DEC· HOVER THE DOTTED TERMS ↑ TO TRACE THEM
INCOME STATEMENT · $MUSED IN
Revenue1,200→ DSO
Cost of goods sold720→ TURNOVER
… everything else …
BALANCE SHEET · $MUSED IN
Inventory180→ TURNOVER
Receivables120→ DSO
… cash, factories, debt …
Every efficiency ratio marries a flow from the income statement with a snapshot from the balance sheet — that cross-statement marriage is the whole trick.
FAMILY 03 — LEVERAGEACME WIDGETS · 31 DEC 2025
How much is borrowed — and can we carry it?
THE SEESAW QUESTION
DEBT
EQUITY
LIABILITIES $0M · 60%EQUITY $0M · 40%
DEBT-TO-EQUITY
TOTAL LIABILITIESEQUITY=600400=0
$1.50 owed for every $1 the owners put in.
INTEREST COVERAGE
EBITINTEREST=24040=0
Operating profit covers the interest bill six times over.
INTEREST COVERAGE SCALE
6.0× COVERAGE
<1.5× CAN’T COVER1.5–3× THIN>3× AMPLE
Leverage is a seesaw ⚖ — it lifts returns when times are good, and tips fast when they’re not.
FAMILY 04 — PROFITABILITYACME WIDGETS · FY2025
Is all this effort worth it?
THE WORTH QUESTION
REVENUE
$1,200M100%
GROSS PROFIT
$480M40%
OPERATING
$240M20%
$150MNET · 12.5%
RETURN ON EQUITY (ROE)
NET INCOMEEQUITY=150400=0
What shareholders earn on every dollar of their stake.
RETURN ON ASSETS (ROA)
NET INCOMETOTAL ASSETS=1501,000=0
What the whole machine produces, however it’s financed.
Margins ask “how much do we keep?” — returns ask “how hard does the money work?”
CAPSTONE — THE DUPONT LENSTYING THE FAMILIES TOGETHER
ROE, dissected
One return, three levers — and each lever belongs to a family we’ve already met.
The middle terms cancel like units — what’s left is profit per equity dollar. DuPont isn’t a new ratio; it’s an X-ray of the one you already had.
Every ROE story is one of three plots: sell dear, sell fast, or borrow bold — great companies pick one and own it.
APPLICATION — READ A RIVALSAME INDUSTRY · SAME YEAR · $M WHERE SHOWN
Two companies. Two strategies.
RATIOACME WIDGETSBETA CORP
CURRENT RATIO2.0×0.9×
QUICK RATIO1.1×0.4×
DEBT / EQUITY1.5×3.2×
INTEREST COVERAGE6.0×1.8×
NET MARGIN12.5%4.0%
INVENTORY TURNOVER4.0×9.5×
ROE37.5%18.0%
So… which one is healthier?
THE READ
Trick question — they’re playing two different games. Acme: premium margins, a cushioned balance sheet, slower inventory. Beta: razor-thin prices, lightning stock turns, debt-fueled.
Ratios don’t declare winners — they expose the strategy, and the risk that comes with it.
YOUR TURN — LIVE ACTIVITYPENCILS OUT · ANSWERS REVEAL ON CLICK
Your turn — be the analyst.
WidgetCo’s books are open below. Work each ratio on paper first — the next click reveals the answer and the verdict.
WIDGETCO — BALANCE SHEET · $M
Current assets300
cash 60 · receivables 90 · inventory 150
Fixed assets600
TOTAL ASSETS900
Liabilities500
Equity400
TOTAL L + E900
WIDGETCO — INCOME STATEMENT · $M
Revenue1,000
Cost of goods sold600
Operating expenses270
Interest25
NET INCOME80
1
CURRENT RATIOcan WidgetCo pay its bills this year?
3002000COMFORTABLE — BARELY
2
DSOhow fast do customers actually pay?
901,000× 3650d3 DAYS PAST 30-DAY TERMS
3
DEBT / EQUITYhow much of WidgetCo is borrowed?
5004000MODERATE
4
NET MARGINhow much of each sales dollar survives?
801,0000%THINNER THAN ACME’S 12.5%
THE VERDICT — WOULD YOU LEND TO WIDGETCO?
Yes — but price it for risk. Liquidity sits a whisker above the line, customers drift past their terms, and every $100 of sales keeps just $8. WidgetCo runs on turnover and hope: lend against collateral, not charm.
HEALTH & SAFETY — CAVEATSINF25703 · FINANCIAL STATEMENTS & RATIOS
Ratios are a stethoscope — not a verdict.
CAUTION Nº1
Industry matters
A supermarket’s 1% net margin is normal; a software company’s 1% is a fire alarm. Compare inside industries only.
CAUTION Nº2
Time beats a point
One year is weather; five years is climate. Always chart the trend before quoting a number.
CAUTION Nº3
Policies differ
FIFO vs LIFO, depreciation choices — identical cash, different ratios. Read the footnotes.
CAUTION Nº4
One-offs distort
Sold a factory? That “record profit” is a mirage. Strip out the unusual before judging.
CAUTION Nº5
Seasonality hides
A toy retailer on Dec 31 looks flush; on Mar 31, broke. Same company, different snapshot.
Garbage in → garbage out. Ratios point at questions; the statements themselves hold the answers.
RECAP — THE CHEAT SHEETINF25703 · TAKE THIS HOME
LIQUIDITY & EFFICIENCY
Current ratiobills we can cover this year
CA ÷ CL
Quick ratiosame, without inventory
(CA − INV) ÷ CL
Inventory turnoverhow fast stock sells
COGS ÷ AVG INV
DSOdays to get paid
(AR ÷ REV) × 365
LEVERAGE & PROFITABILITY
Debt / equityhow much is borrowed
LIAB ÷ EQUITY
Interest coveragecan we service the debt
EBIT ÷ INTEREST
Return on equity — ROEwhat shareholders earn on their stake
NI net income · CA current assets · CL current liabilities · AR receivables · INV inventory · EBIT earnings before interest & tax
Questions? Bring them.
INF25703 FIELD WORK — DUE NEXT CLASS
Pick any public company. Download its annual report. Compute five of today’s ratios — then write one paragraph: what is its strategy, and what is its risk?