How to read a balance sheet

What are the three sections?

Each section is split into current items, due or usable within a year, and long-term items.

Items are listed at their recorded cost, less depreciation, not at what they could be sold for today.

What does an example look like?

How do you read it?

1. Check it balances

   Total assets must equal liabilities plus equity.

2. Look at cash

   Does it match the bank, and is it enough for the next months?

3. Compare current assets and liabilities

   Working capital and the current ratio.

4. Check what is owed

   Sales tax payable, loans and cards, and when they are due.

5. Look at equity over time

   Rising with profit kept in, falling with losses and draws.

Which simple ratios help?

In the example, current assets are $42,000, cash and inventory, and current liabilities are $9,000, cards, bills and sales tax. Working capital is $33,000 and the current ratio is about 4.7, comfortable for a small business. Total liabilities divided by equity, about 0.6 here, shows how much of the business is funded by debt.

What warning signs should you look for?

• Cash falling month after month while profit looks fine.
• Sales tax payable growing, which may mean collected tax is not being paid over. See collected sales tax but did not remit.
• Credit card balances rising faster than sales.
• Inventory growing much faster than sales, suggesting slow-moving stock.
• Negative equity, meaning liabilities exceed assets.

What are receivables and payables?

Accounts receivable are amounts customers owe you for invoices not yet paid; accounts payable are bills you owe suppliers. Businesses using the cash method may not show them, but tracking them still matters for managing cash. A growing receivables balance can mean customers are paying late. See cash vs accrual accounting.

See accounts receivable vs accounts payable.

How often should you review it?

Monthly, after the books are reconciled, alongside the profit and loss statement. Comparing each month with the previous one, and with the same month last year, shows trends that a single balance sheet cannot. Lenders and investors usually ask for year-end balance sheets, and partnerships and corporations report one on their tax returns. See bank reconciliation.

Lenders read it closely. See getting your books ready for a loan.

How does equity work in an LLC?

For a single-member LLC, equity shows the owner's contributions plus profit, less draws. Draws reduce equity, not profit. For a corporation, equity shows paid-in capital and retained earnings. See bookkeeping for a single-member LLC and contributions vs loans.

Does the balance sheet matter for tax?

Partnerships and corporations report a balance sheet on their federal returns, Schedule L, unless they meet the small business exceptions, and it must agree with the books. For sole proprietors it is not filed, but it supports the figures on Schedule C, such as inventory and depreciation, and shows owner draws, which are not deductible. See Form 1065.

How does it fit with the P&L?

Profit for the year flows into equity. If profit is high but cash is low, the balance sheet shows where the money went: into inventory, receivables, loan repayments or draws. See how to read a profit and loss statement.

See the cash flow statement explained.

This guide is general information. It is not tax or legal advice for your situation.