A balance sheet is one of three statements that are used to monitor and predict a business’ financial health. This guide outlines what should be included in a balance sheet and how to understand it.
When running a business, it’s vital that you consistently measure and review its financial performance to ensure you have enough funds to keep going opens in new window, deliver the investments you need, and meet the targets in your business plan opens in new window.
To do this, you need the following three statements:
- A profit and loss account opens in new window (also known as an income statement) that shows a company’s income and expenses at a specific point in time. The statement will indicate whether you are making a profit or loss.
- A cash flow statement that shows the money coming in and going out of your business.
- A balance sheet that outlines your business’ assets, liabilities, and shareholder’s equity at a specific point in time.
Together these three statements are crucial for monitoring and predicting your business’ financial health as well as understanding if your business is profitable.
With the information provided by the statements, you can take action to address any issues if required.
This guide outlines the sections in a typical balance sheet and how to understand them.
What is a balance sheet?
A balance sheet provides a snapshot of a business’ assets, liabilities, and shareholders’ equity at a specific point in time.
Download the free Start Up Loans balance sheet template opens in new window to help you get started.
It is called a balance sheet because a statement is one that is balanced according to this fundamental formula:
Assets = liabilities + shareholder’s equity
A balance sheet has several benefits. It helps to:
- identify if you have enough funds to cover your business’ short-term obligations.
- show if your business’ level of borrowing is too high.
- indicate to potential investors and finance lenders what your company owns and owes and whether they should invest in it or provide debt funding.
Limited companies are legally required to include a balance sheet opens in new window and profit and loss account when they submit their annual accounts to Companies House opens in new window.
Sole traders opens in new window are not legally obligated to produce financial statements, but it is good practice so that the financial health of the business can be monitored.
How to read a balance sheet
The three sections of a balance sheet are:
Assets are the things that a business owns.
Current assets are short-term assets that are used for a business’ day-to-day operations and to pay its expenses. They are typically used up and converted into cash within a year.
- cash and cash equivalents
- accounts receivable (money that is owed to the business)
- inventory (things the company intends to sell to customers, such as stock and supplies)
- temporary investments (financial investments that will be sold in the near future)
- prepaid expenses (such as insurance, property leases, and rent)
- other liquid assets that can be converted into cash within a year (such as tax refunds).
Non-current assets are assets that a business intends to use and own for a period that is longer than one year.
Non-current assets can be split into two types:
- Tangible fixed assets: These are things a business owns that can be physically touched. They are often called property, plant, and equipment (PP&E). Examples include machinery, vehicles, office furniture opens in new window, IT equipment, buildings and land.
- Intangible fixed assets: These are things that a business owns which can’t be physically touched. Examples include trademarks opens in new window, patents and copyrights opens in new window, website domain names, software, and licensing agreements. ‘Goodwill’ is another intangible fixed asset. This is a term which covers things like brand reputation opens in new window and customer loyalty.
Liabilities, also called debts, are money a business owes to other people, companies, or organisations.
It’s important that you closely monitor your liabilities and ensure that they don’t get so high that you are unable to afford to settle them.
Liabilities can be either current and due to be paid within a year or long-term, which are debts due to be paid within a period of more than 12 months.
Current liabilities include:
- accounts payable (such as invoices to suppliers that need to be paid by a business)
- short-term debt such as credit cards and overdrafts
- employee and contractor salaries
- unpaid tax bills opens in new window
- overdue rent payments
- electricity, gas, water, and other utility bills opens in new window
Long-term liabilities include loan and mortgage repayments that must be paid over a period longer than one year.
Equity, often referred to as owner or shareholder’s equity opens in new window, is what the business is worth once liabilities have been subtracted from assets.
It covers the cash a business owner and other shareholders initially invested into the business when it was started, as well as additional income and losses that have been made.
Equity appears on the balance sheet as:
- the portion of the business owned by the shareholders and is usually represented as shares.
- retained earnings which is the amount of profit minus any dividends paid out to the owner/shareholders and any losses that have been generated.
A balance sheet needs to be balanced
Your aim should be to have a balance sheet that is balanced.
This means that the total assets equal the sum of the liabilities and the equity.
If the balance sheet is not balanced, it could indicate incorrect data or miscalculations have been included.
It is recommended that you speak to your accountant opens in new window for help and guidance.
The key to achieving a positive balance sheet is healthy working capital.
This is the cash left after accounting for money coming in and out over a given period and is what a business needs to maintain day-to-day operations.
For more guidance, read our guide to improving your working capital opens in new window here and find details about working capital finance options. opens in new window
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Reference to any organisation, business and event on this page does not constitute an endorsement or recommendation from the British Business Bank or the UK Government. Whilst we make reasonable efforts to keep the information on this page up to date, we do not guarantee or warrant (implied or otherwise) that it is current, accurate or complete. The information is intended for general information purposes only and does not take into account your personal situation, nor does it constitute legal, financial, tax or other professional advice. You should always consider whether the information is applicable to your particular circumstances and, where appropriate, seek professional or specialist advice or support.