Understand a balance sheet

Whether or not you have an accountant, every business owner should be able to draw up and use a balance sheet - and be able to understand it. It really helps you stay on top of finances and understand what state your business is in. And this guide is here to help, by explaining:

  • What a balance sheet is
  • Why it's important
  • What's in a balance sheet
  • What you're aiming for

What a balance sheet is

A balance sheet gives a snapshot of the state your business is in, measured in terms of assets and liabilities.  Assets are things or sums of money you own or are owed - cash, inventories, accounts receivable from customers, property, equipment.  Liabilities are things or amounts you owe others - bank debt and accounts payable to suppliers or creditors.

Why it's important

Your balance sheet is used to assess the value of your business at any given point. It helps you keep track of finances, and ensure that your liabilities don't outweigh your assets, which helps keep you out of serious debt and financial trouble. It's also one of the first things an investor or bank manager will want to see, as it explains the state of your business financially. It's useful for your annual accounts too.

What's in a balance sheet

Anything within or owed by your business that has monetary value - or that is physical money - is included in the balance sheet. Everything is then split into four groups.

Things that can be liquidated (sold for cash) within one year, including stock, cash, and money owed by customers are current assets. Think of "current" as short-term.

Fixed assets, on the other hand, are more long-term: including property, machinery, patents and long-term investments.

Current liabilities, then, are what the business owes in the short-term, such as money owed to suppliers, taxes due, short-term loans and overdrafts. 

Long-term liabilities are what the business owes in the long-term - to be paid after one year, as well as capital and reserves. You then have total assets - the combined value of all assets, remembering to account for depreciation and interest - and total liabilities.

What you're aiming for

Total assets should always equal liabilities plus owner's equity if everything's calculated correctly - as if you sold all the assets and paid off the liabilities, what you'd have left is the equity. Your current assets should hopefully always be greater than your current liabilities. If they are, you're generally able to pay bills and can survive unexpected costs. Ideally, a healthy business has current assets that are twice as large as current liabilities. If your current assets are smaller than current liabilities, you're probably struggling financially.

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