What Is a Balance Sheet? A Guide With Examples

A balance sheet is one of the three most important financial statements for any business, providing a snapshot of the company’s financial position at a specific point in time.

Whether you’re a startup owner trying to secure funding, a small business considering hiring an accountant or purchasing accounting software, or a finance student learning the ropes, understanding balance sheets is a must.

This guide will walk you through everything you need to know about balance sheets.

Key Takeaways

• A balance sheet shows your business’ assets, liabilities, and equity at a specific moment, helping you understand your overall financial position.
• The fundamental balance sheet equation is: Assets = Liabilities + Equity.
• Balance sheets work alongside income statements and cash flow statements to provide a complete picture of business health.
• Regular balance sheet analysis helps you make business decisions, secure funding, and identify potential financial issues early.

Understanding Balance Sheets

What is a balance sheet?

A balance sheet is a financial statement that captures everything your business owns (assets) and owes (liabilities), as well as the capital invested by shareholders (equity) at a specific moment in time.

Think of it as a financial snapshot—while other financial statements show what’s happened over time, a balance sheet shows your exact financial position on a particular date.

The basic balance sheet formula

The fundamental principle of a balance sheet is that it must always balance according to this equation:

Assets = Liabilities + Equity

This makes intuitive sense because everything your company owns (assets) must have been financed either through debt (liabilities) or through investment/retained profits (equity). Let’s look at a simple example to get started:

Notice that the total assets match the total liability and equity of the company.

Balance sheets differ from other financial statements

Balance sheets are just one part of accounting for a company. They work alongside other key financial statements:

• Balance sheets show what you own and owe at a specific moment.
• Income statements show profitability over a period.
• Cash flow statements show how money moves in and out over a period.

Balance Sheets Help Guide Business Decisions

Balance sheets have several useful functions for businesses, large and small.

Using balance sheets for strategic insight

If you regularly review your balance sheets, you can identify potential financial issues before they become significant problems. For example, tracking changes in the current ratio (current assets divided by current liabilities) can alert you to developing cash flow challenges.

Balance sheets also provide valuable insights into business growth patterns. By comparing balance sheets across different periods, you can spot trends in asset acquisition, debt management, and overall financial strength.

Regular balance sheet reviews can reveal hidden inefficiencies in your business, too. For instance, consistently high inventory levels might suggest oversupply issues, while growing accounts receivable could indicate the need for stricter credit control policies.

Showcasing financial position with your balance sheet

When seeking external funding, your balance sheet becomes an essential tool for demonstrating financial stability. Banks and investors scrutinise this document to assess creditworthiness and determine whether your business can handle additional debt or investment.

For tax purposes, your balance sheet supplies important information about asset values, depreciation, and business structure. This helps ensure accurate tax reporting and supports proper financial planning throughout the tax year.

Balance sheets help maintain transparency with those you work with. Whether dealing with shareholders, employees, or potential business partners, a clear and accurate balance sheet builds confidence in your business’ financial management and future prospects.

Components of a Balance Sheet

Assets

Assets are everything your business owns that has monetary value. The order of assets on a balance sheet matters—they’re listed by liquidity, meaning how quickly they can be converted to cash. This helps lenders and investors assess your business’ ability to meet short-term obligations.

• Current assets are items that can be converted to cash within one year, including cash and bank balances, accounts receivable (money owed by customers), inventory, and prepaid expenses.
• Non-current assets aren’t intended for conversion to cash within a year. These include property, plant and equipment, long-term investments, and vehicles.
• Intangible assets are non-physical assets that still have value, such as patents, trademarks, copyrights, and goodwill.

Here’s an example showing how assets might appear on a balance sheet:

Liabilities

Liabilities represent everything your business owes to others. Like assets, liabilities are categorised based on when they need to be paid.

• Current liabilities are debts that must be paid within one year. These typically include your accounts payable, which is money owed to suppliers, as well as any short-term loans or overdrafts. You might also have tax liabilities, including VAT and PAYE, that fall into this category.
• Non-current liabilities are all long-term debts and obligations that won’t be due within the next 12 months. The most common examples are long-term bank loans and bonds payable.

Off-balance sheet liabilities, such as operating leases or pending legal claims, don’t appear directly on the balance sheet but can significantly impact your business’ financial health. These should be disclosed in the accompanying notes.

Here’s how liabilities might appear on a balance sheet:

Shareholder’s equity

Shareholder’s equity, sometimes called owner’s equity, represents the net worth of your business. It’s what would be left if you sold all assets and paid off all liabilities. This section of the balance sheet shows both the initial investments made into the business and its accumulated profits or losses.

Common stock represents the initial and subsequent investments made by shareholders. For small businesses, this might simply be the owner’s capital contribution.

Retained earnings show the accumulated profits that haven’t been distributed to shareholders as dividends. Together, these elements tell the story of your business’ growth and profitability over time.

Here’s a typical equity section:

Reading and Analysing a Balance Sheet

Start by checking that the fundamental equation balances: the total assets should equal the total liabilities plus equity—it’s a reality check that ensures all the business’ resources are accounted for.

The current ratio is one of the most useful metrics you can calculate from your balance sheet. Simply divide current assets by current liabilities. A ratio above 1.0 indicates you can cover your short-term obligations, while a higher ratio suggests stronger financial health. However, too high a ratio might mean you’re not investing enough in growing your business.

The acid test ratio (current assets minus inventory, divided by current liabilities) provides a stricter measure of liquidity than the current ratio, as it excludes harder-to-sell inventory.

Look for trends in working capital (current assets minus current liabilities). This figure indicates your business’ operational liquidity. A declining trend might signal future cash flow problems, while steady growth usually indicates good financial management.

The debt-to-equity ratio (total liabilities divided by shareholder equity) helps assess financial leverage. UK banks often look for ratios below 2:1, though acceptable levels vary by industry.

Here’s a complete example of a small business balance sheet that brings all these elements together:

Creating a Balance Sheet for Your Business

Creating your first balance sheet is easy if you break it down into steps.

1. Determine the reporting date: Begin by selecting the date for your balance sheet, typically the end of a month or financial year. This date marks the point in time for which you’ll gather all financial information. Make sure you have access to all your financial records up to this date and that every transaction has been properly recorded in your accounting system.
2. List your assets: Start by documenting all your assets. Begin with current assets such as cash, inventory, and accounts receivable. Then, record your fixed long-term assets, including property, equipment, and vehicles. Finally, add any intangible assets like patents or trademarks. Sum up all these categories to get your total assets figure.
3. Record your liabilities: Document all amounts your business owes to others. Start with current liabilities such as accounts payable and short-term loans that need to be paid within a year. Then, add your long-term liabilities like mortgages and long-term loans. Calculate the total for all your liabilities combined.
   Calculate shareholder equity: Work out the shareholder equity section by including your share capital and retained earnings. This represents the net worth of your business to its owners. Include any other equity items and calculate the total shareholder equity figure.
   Check the balance: This crucial step ensures your balance sheet actually balances. Verify that your total assets equal the sum of your total liabilities plus shareholder equity. Review all entries for completeness and accuracy, and double-check all your calculations.
4. Add supporting details: Complete your balance sheet by adding explanatory notes for significant items. Include clear explanations for any major changes from previous periods and document the accounting methods you’ve used. This context helps readers understand your financial position better.