A to Z glossary of business loan and funding terms

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, deliver the investments you need, and meet the targets in your business plan.

To do this, you need the following three statements:

• A profit and loss account (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.

The statements are also usually required when a business owner looks for equity investment or applies for a loan or a grant.

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 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 and profit and loss account when they submit their annual accounts to Companies House.

Sole traders 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

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.

They include:

• 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, IT equipment, buildings and land.
• Intangible fixed assets: These are things that a business owns which can’t be physically touched. Examples include trademarks, patents and copyrights, website domain names, software, and licensing agreements. ‘Goodwill’ is another intangible fixed asset. This is a term which covers things like brand reputation and customer loyalty.

Liabilities

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
• overdue rent payments
• electricity, gas, water, and other utility bills

Long-term liabilities include loan and mortgage repayments that must be paid over a period longer than one year.

Equity

Equity, often referred to as owner or shareholder’s equity, 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 might also suggest a cash flow issue that needs dealing with.

It is recommended that you speak to your accountant 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 here and find details about working capital finance options.