If the profit and loss statement tells you whether you made money, the balance sheet tells you where you stand. It's a snapshot of your business on a single date: everything it owns, everything it owes and what's left over for its owners. This guide explains the three parts of a balance sheet, why it always balances and how to read one usefully.
The accounting equation
Every balance sheet rests on one equation:
Assets = Liabilities + Equity
What the business owns was paid for either by borrowing (liabilities) or by its owners (equity, including profits kept in the business). Double-entry bookkeeping keeps this equation true after every single transaction, which is why a balance sheet always balances. If you're new to double entry, start with double-entry bookkeeping explained.
A simple balance sheet
| Assets | |
|---|---|
| Bank account | £5,640 |
| Accounts receivable | £1,020 |
| Equipment | £2,400 |
| Total assets | £9,060 |
| Liabilities | |
| VAT payable | £410 |
| Supplier bills (accounts payable) | £650 |
| Total liabilities | £1,060 |
| Equity | |
| Owner's capital | £5,000 |
| Retained earnings | £3,000 |
| Total equity | £8,000 |
| Liabilities + equity | £9,060 |
Assets: what you own or are owed
- Current assets turn into cash within a year: bank balances, money customers owe you (receivables), stock and prepayments.
- Non-current (fixed) assets are kept for longer: equipment, vehicles, property. Their value is usually reduced over time through depreciation.
Liabilities: what you owe
- Current liabilities are due within a year: supplier bills, VAT and other taxes owed, short-term loans and credit cards.
- Non-current liabilities are due later: longer-term loans and finance agreements.
Equity: the owners' stake
Equity is what would be left for the owners if every asset were sold for its book value and every liability paid. It's made up of:
- Capital the owners put in
- Retained earnings: profits kept in the business over time
- Minus drawings or dividends taken out
How to read a balance sheet
Can you pay your bills? The current ratio
Current assets ÷ current liabilities. Above 1 means you have more short-term resources than short-term obligations. Very low suggests cash pressure ahead.
How much is borrowed? Debt to equity
Total liabilities ÷ total equity. A higher number means more of the business is funded by borrowing, which increases risk if income drops.
Are customers paying? Receivables
A large and growing receivables balance can mean customers are paying slowly. An aging report shows which invoices are late.
Is the bank balance real?
The balance sheet's bank figure should match your bank statement on the same date. If it doesn't, something is missing from your books.
Balance sheet vs profit and loss
The profit and loss statement covers a period; the balance sheet is a moment in time. They connect through equity: each period's net profit is added to retained earnings. Read them together. A profitable P&L with a shrinking bank balance and soaring receivables tells a very different story from profit alone.
Common balance sheet mistakes
- Recording equipment as an expense, which understates assets and profit.
- Leaving VAT in sales instead of a liability account.
- Personal spending mixed in, which distorts both assets and equity.
- Never reconciling the bank against statements.
- Old receivables nobody will pay still counted as assets. Write them off.
A balance sheet without the spreadsheet
Zelvorm Books builds your balance sheet from your journal automatically and checks it balances, alongside your trial balance and profit and loss. It's free double-entry bookkeeping for small businesses.
How everyday transactions change the balance sheet
Every transaction keeps the equation in balance. Here's how common ones move the numbers:
| Transaction | Assets | Liabilities | Equity |
|---|---|---|---|
| Owner invests £5,000 | Bank +£5,000 | Capital +£5,000 | |
| Buy a £1,200 laptop with cash | Bank −£1,200, Equipment +£1,200 | ||
| Invoice a client £1,440 incl. VAT | Receivables +£1,440 | VAT payable +£240 | Profit +£1,200 |
| Client pays the invoice | Bank +£1,440, Receivables −£1,440 | ||
| Receive a £650 supplier bill | Payables +£650 | Profit −£650 | |
| Take out a £3,000 loan | Bank +£3,000 | Loan +£3,000 | |
| Owner withdraws £1,000 | Bank −£1,000 | Drawings −£1,000 |
Notice that buying equipment and getting paid don't change equity at all: they just swap one asset for another. Only income, expenses, investment and withdrawals move equity.
Depreciation in plain English
Equipment wears out, so its value on the balance sheet should fall over time. Depreciation spreads the cost across the years you use it. A £1,200 laptop expected to last three years might be depreciated by £400 a year: each year, £400 moves from the asset into an expense on your profit and loss. After three years, its book value is zero.
Depreciation methods and tax treatment vary, and tax allowances can work differently from the depreciation in your accounts, so ask your accountant how to handle larger purchases.
Working capital: the number that keeps you afloat
Working capital = current assets − current liabilities.
It's the cushion available to run the business day to day. Positive and stable is healthy. Shrinking working capital, even while you're profitable, is an early warning: customers may be paying slower, stock may be piling up, or short-term debt may be growing.
Ways to improve it:
- Invoice promptly and chase late payers; see accounts receivable aging.
- Take deposits on larger jobs.
- Negotiate longer supplier terms.
- Avoid funding long-term purchases with short-term borrowing.
A year-end balance sheet checklist
- Bank: matches the bank statement on the year-end date.
- Receivables: every invoice on the list is genuinely still owed; write off any that won't be paid.
- Payables: every bill you owe is recorded, including ones that arrived after year end for work before it.
- VAT and taxes: balances agree with your returns.
- Fixed assets: the list matches what you actually own, with depreciation recorded.
- Loans: balances agree with lender statements.
- Equity: capital and drawings match what the owners put in and took out.
A clean balance sheet at year end is the single biggest thing that keeps accountancy fees down.
Reading a balance sheet for warning signs
- Bank falling while profit rises: cash is tied up somewhere, usually receivables.
- Liabilities growing faster than assets: the business may be borrowing to cover losses.
- Negative equity: liabilities exceed assets, which needs attention and advice.
- Old receivables: money that's unlikely to arrive inflating your assets.
The short version
A balance sheet shows assets, liabilities and equity on a given date, and assets always equal liabilities plus equity. Use it to check you can pay your bills, how much you rely on borrowing and whether customers are paying, and always read it alongside your P&L.
