Balance Sheets Explained! How to Read It and Why It Matters

One of the most complicated financial documents a business can have is a balance sheet. And if you’re like most business owners, it can be really confusing when you try and read one and understand what it says, 

Well, today I’m breaking that down for you in the simplest way possible. Running a business is hard enough, you shouldn’t need an accounting degree just to understand your financial documents. 

Oftentimes, I run into a business owner and they are struggling to read their cash flow statements, their profit loss statements or their balance sheets. On top of that, how do they know what they should do with those numbers once they see them? 

I’m big on making things simple, so I’m going to be walking you through what a balance sheet is, how to read it, and how you can utilize it in your business. 

Side note: If you’re trying to read a profit & loss statement, or a cash flow statement, we have breakdowns on those as well.

The 3 Parts of a Balance Sheet

A balance sheet is broken into three core sections:

• Assets
• Liabilities
• Owner’s equity

The goal of a balance sheet is to get these 3 categories to balance (I wonder where they came up with the name?).  

The equation is simple. Take the assets, subtract the liabilities, and you should end up with your owner’s equity. 

Assets – Liabilities = Owner’s Equity

Look at your balance sheet to see if these numbers work out. If they don’t add up, then that means something went wrong with the the bookkeeping and we need to go fix it. 

Next, let’s take a look at each section individually. 

Assets

An asset is something the company owns that has tangible value. Typically this is broken up into two sections; you’ll have current assets and non-current assets. 

A current asset is anything that the company expects to turn into cash within a year. Some examples are inventory, accounts receivable, or even cash in the bank. Several things might fall into this category, but their common bond is that they are something that you expect to become cash within a year. 

Non-current assets are things that might take more than a year or are not expected to turn it into cash. This could be land or property or patents. Again, several things might fall into this category, but non-current assets are where it might take a while to recoup that cash, or you’re not expecting to get it back out. 

Remember, assets are things of value. So these are the things you have that are adding value to the business, whether it is physical cash or not. 

Liabilities

The next section is liabilities. These are the exact opposite of assets. While assets are something that the company owns, a liability is something that the company owes. 

Once again, this is going to be broken into the same two sections. You’re going to have your current and your non-current liabilities. 

Current liabilities are debts you expect to pay off within a year. So this could be payroll expenses, accounts payable, or a small short-term loan. 

Non-current debts are debts that you do not expect to pay off within a 12 month period. This could be tax debts or leases on properties. 

It’s important for a business to manage the amount of liabilities they take on. If a business has a heavy load of liabilities, it’s potentially an indicator of financial struggle. 

Owner’s Equity

The third and final section is owner’s equity. This is anything left in the business after liabilities have been considered. 

This section is important because it shows your retained earnings, or how much money stayed in the business. Remember the equation from early? Assets – Liabilities = Owner’s Equity? We’ve taken the assets (what you have) and subtracted the liabilities (what you owe), and now we can see the actual cash value in the business.  

This section is a vital indicator to the health of your business. If a potential buyer or an outside party is evaluating your finances, they want to see some money there. 

If your liabilities outweigh your assets, then obviously that’s not a good thing. Your business is upside down and running in the red and at risk of financial disaster. 

How to Use The Balance Sheet For Your Business

Now that we know how to read your balance sheet, what can you do with that information? 

In a nutshell, a balance sheet is going to show you whether your company, or another company, is thriving or struggling.

As a business owner, you can use it to guide growth and guide your decision making. You can see areas of waste or areas of need and growth opportunities. 

You can also use a balance sheet to see your relationship with debt. If your cash flow is tied up in debt, we can see that in a balance sheet and we can start seeing a path forward to free that money up within your business. 

It gives you the chance to take that information and then start making some positive changes. 

Now this is where a lot of business owners get stuck. You see that there’s a problem. Maybe you’re struggling. What do you do next? 

While accounting documents can show you exactly what’s been happening in your business finances, I’m a believer that you need a system to manage the day to day cash in your business. 

And that’s exactly what we do with our clients. We help them implement a cash system that not only gives them clarity and control over where their money is going today, but we also help them scale in a financially healthy way for the future. 

If you’ve been struggling financially in your business, don’t put it off any longer. Schedule a free consultation with one of our coaches. They will dig into your business, see what’s been going on, and show you how you can fix it.