A Beginner’s Guide to Understanding the Balance Sheet

Business owners tend to focus on the Profit and Loss Statement as it shows the income and expenses flowing through their business. Also, the categories (accounts) on the Profit and Loss Statement are terms they tend to use in their day-to-day business dealings.

The Balance Sheet however, uses accounting terms that might not be used on a daily basis and therefore, can be a little intimidating. If that’s how you feel, you’re not alone as We hear regularly from business owners, that they don’t fully understand the balance sheet. This article will breakdown the terms you might find on a balance sheet.

What Is a Balance Sheet?

Think of a balance sheet like a snapshot of your finances. It shows what a business owns (assets), what it owes (liabilities), and what’s left over for the owners (equity). This snapshot helps business owners, investors, and lenders understand how the business is doing financially.

The balance sheet follows a basic formula:

Assets = Liabilities + Equity

This equation is called the accounting equation, and it always stays in balance (hence the name “balance sheet”). Let’s explore each part of the equation.

Assets: What the Business Owns

Assets are all the things a business owns that have value. These can be physical items (tangible) or things that aren’t tangible (items that aren’t physical but have value). Here are some examples:

Tangible:

• Cash: Money in the bank or on hand.
• Accounts Receivable: Money customers owe the business.
• Inventory: Products the business plans to sell.
• Equipment: Tools, machinery, or computers used in the business.
• Property: Land or buildings owned by the business.

Intangible:

• Intellectual property: Patents, trademarks, copyrights.
• Goodwill: Value from customer loyalty, public reputation.
• Brand recognition: Logos, taglines, etc.

Assets are usually divided into two categories:

• Current Assets: Items the business can turn into cash quickly, usually within a year (like cash or inventory).
• Non-Current Assets: Items the business plans to use longer than a year (like equipment or property).

Liabilities: What the Business Owes

Liabilities are debts or obligations—money the business owes to others. Here are some common examples:

• Loans: Money borrowed from a bank or other lender.
• Accounts Payable: Money owed to suppliers or vendors.
• Taxes Payable: Taxes the business owes to a government agency.

Like assets, liabilities are divided into two categories:

• Current Liabilities: Debts that must be paid within a year (like short-term loans or bills).
• Non-Current Liabilities: Debts that are due over a longer period (like a mortgage).

Equity: What’s Left Over

Equity is the owner’s share of the business. It’s what’s left when you subtract liabilities from assets. In other words:

Equity = Assets – Liabilities

If a business sold everything it owns and paid off all its debts, the remaining money would be the owner’s equity. Examples include:

• Owner’s Contributions: Money the owner(s) has invested in the business.
• Retained Earnings: Profits the business has kept rather than paying out to the owner(s).

Why Is the Balance Sheet Important?

A balance sheet is like a report card for your business. It helps answer important questions, such as:

• Is the business financially healthy? Comparing assets and liabilities can show whether the business has enough resources to cover its debts.
• How much is the business worth? Equity gives an idea of the business’s value to its owners.
• Are there any red flags? For example, too much debt compared to assets could signal trouble.

The balance sheet report provides a snapshot of what your business owns (assets), owes (liabilities), and its overall value (equity). We recommend reviewing your balance sheet regularly to monitor the financial health of your business.