How to Read a Balance Sheet: A Small Business Owner's Guide

A profit and loss statement tells you what happened over a period. A balance sheet tells you where the business stands on one day, usually the last day of the month. The two reports are connected, and owners who read both make better decisions than owners who only look at profit.

The one equation behind it

Every balance sheet follows the same rule: assets equal liabilities plus equity. If the report does not balance, something is wrong in the books. When your bookkeeper hands you a balanced report, it means every transaction was recorded with two sides, which is the basic check that the records are internally consistent.

Assets: what the business owns

• Cash and bank accounts. Should match your bank statements on the report date. If they do not, the account has not been reconciled.
• Accounts receivable. Money customers owe you. Our guide to accounts receivable aging explains how to read old balances.
• Inventory. Goods held for sale, if your business carries stock.
• Equipment and other fixed assets. Things the business owns for long-term use, shown with accumulated depreciation where it is tracked.

Liabilities: what the business owes

• Accounts payable. Bills you have received but not yet paid.
• Credit cards and loans. Balances that should match the lender or card statement.
• Sales tax and payroll liabilities. Money collected or withheld for someone else that you have not yet remitted.
• Deferred revenue or customer deposits. Cash received for work not yet delivered, where that applies.

Equity: what is left

Equity includes money the owners put in, money they took out as draws or distributions, and the profit the business has kept over time. Owner draws are not an expense, and they show up here rather than on the profit and loss statement. If equity is falling while the profit and loss shows a profit, draws or distributions are usually the reason.

Five checks to run every month

1. 1Do the cash balances match the bank statements?
2. 2Is anything sitting in an uncategorized or suspense account?
3. 3Do loan and credit card balances match the lender statements?
4. 4Are old receivables still listed as collectible, or should someone follow up?
5. 5Do liability balances, such as sales tax, match what you expect to owe?

Warning signs

Negative cash, a large unexplained balance in an ask-my-accountant style account, an asset that never changes, or a liability that never gets paid down are all signs the books need attention. None of these prove a problem by themselves, but each is worth a question.

Where this fits in your monthly package

A tax-ready monthly package includes both reports, reconciled. If you want a bookkeeper to prepare and explain them in your own QuickBooks or Xero file, see monthly bookkeeping. Pair this with our guide on reading a profit and loss statement.

Frequently asked questions

Keep reading

Financial Reports

How to Read a Profit and Loss Statement (P&L) for Your Small Business

A profit and loss statement shows whether your business earned more than it spent over a period. Here is how to read each section and what to look for every month.

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Reconciliation is the check that your books agree with the bank. It is a small monthly task that catches duplicates, missing entries and mistakes while they are still easy to fix.

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