What is a balance sheet?
A balance sheet is a financial statement showing what a business owns, what it owes and the owners' stake in it at a single point in time.
What a balance sheet means
Where the profit and loss account covers a period, the balance sheet is a snapshot on one date, usually the last day of the financial year. It rests on one equation:
Assets − liabilities = equity
Everything the business owns, less everything it owes, equals what belongs to the owners. The two sides always balance, which is where the name comes from.
How it is laid out
- Fixed assets: equipment, vehicles, property, goodwill
- Current assets: stock, debtors, cash
- Current liabilities: suppliers, VAT, PAYE, Corporation Tax and loans due within a year
- Long-term liabilities: loans due after more than a year
- Equity: share capital and retained earnings
Example
A two-year-old consultancy company at 31 March:
| Amount | |
|---|---|
| Laptops and equipment | £6,000 |
| Debtors | £18,000 |
| Cash at bank | £31,000 |
| Less creditors and accruals | (£7,000) |
| Less Corporation Tax due | (£11,000) |
| Less director's loan owed to director | (£2,000) |
| Net assets | £35,000 |
| Share capital | £100 |
| Retained earnings | £34,900 |
| Total equity | £35,000 |
Net assets and equity match. The director can see that, although there is £31,000 in the bank, £11,000 of it is owed to HMRC.
Why it matters for your business
The balance sheet answers questions the profit figure cannot. Can the company pay its bills? Are there enough reserves to pay a dividend? How much is owed to the bank, to HMRC or to the director? Lenders, landlords and suppliers look at it before offering credit, and every UK company files a version of it with Companies House each year. Micro-entities can file a very short version, but the full figures still matter for running the business.
What to look for when you read one
- Net assets: positive and growing is good. Negative net assets mean the company owes more than it owns.
- Cash against liabilities: is there enough to pay VAT, PAYE and Corporation Tax when due?
- Debtors: rising faster than sales suggests customers are paying slowly.
- Director's loan account: an overdrawn balance owed by a director can trigger extra tax if not repaid in time.
- Retained earnings: these set the limit for dividends.
Common questions
The profit and loss account shows income and costs over a period, ending in profit or loss. The balance sheet shows assets, liabilities and equity on one date. Profit for the year flows into retained earnings on the balance sheet, which is how the two connect.
Because of double-entry bookkeeping. Every transaction is recorded twice, once as a debit and once as a credit, so total assets always equal total liabilities plus equity. If they do not, something has been posted incorrectly.
More accounts & bookkeeping terms
- Accounting equation
- Accounts payable
- Accounts receivable
- Accrual accounting
- Accruals
- Amortisation
- Assets
- Bad debt