What is a balance sheet? Download your free balance sheet template

Balance sheet definition

A balance sheet is a financial statement that shows:

• what your business owns (assets)
• what your business owes (liabilities)
• shareholders’ equity (the money put into, and generated, by your business)

As the name of the document implies, the separate sections of your balance sheet need to balance. The theory is that what your business owes, as well as the money it has available, are what’s funding its assets.

This means the total assets should equal the combined total of your liabilities and equity. The balance sheet formula you need is:

Assets = Liabilities + Shareholder Equity

What is a statement of financial position?

You may also see a balance sheet called a statement of financial position, which shows a business’s value on a particular date.

A statement of financial position helps a business to monitor its incomings and outgoings.

A balance sheet is just one element of business accounting you can use to understand your financial position – other statements to look at include your profit and loss account, and cash flow.

What does a balance sheet show?

A balance sheet is useful because you can see:

• how easily you can access money, by looking at your current assets
• how much financial risk you can take on, by comparing equity against your liabilities
• how efficiently your business can generate revenue using its assets, by comparing your balance sheet to the profit and loss account

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Download your balance sheet template

Your business’s assets, liabilities, and shareholders’ equity get broken down even further on the balance sheet itself.

Download your free balance sheet template to cross-check this section against the terms used in the balance sheet, so you know how to fill it in.

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Please treat this article and template as a guide only – it’s not financial advice. If you run a limited company you won’t be able to use our balance sheet to complete statutory accounts.

It’s always best to speak to a professional accountant or adviser about your business’s finances.

How to read a balance sheet

A balance sheet format usually includes the company’s assets first, followed by its liabilities and shareholders’ equity.

It’s important to understand the difference between assets such as cash, accounts receivable, and inventory (see below), as well as what they mean for a business’s finances.

On the liabilities side, the key thing to understand is the difference between current and long-term.

When reading a balance sheet, you’ll be aiming to work out if the company’s finances are ‘in balance’, where the value of the assets are equal to the combined value of liabilities and shareholders’ equity.

Balance sheet example: assets

This goes on the left side (or top) of the balance sheet. You separate what your business owns into current assets and fixed assets.

This is in order of liquidity – meaning the assets that you can convert into cash more easily go at the top. Read our guide to liquidity in business to find out more about how it works.

Current assets are what you use day-to-day when running your business, and you’ll typically use them within a year (for instance, the money in your business bank account).

Current assets include:

• cash – this could be money you have readily available, for example it’s in your bank account, or you have cheques you need to pay in (a cash flow forecast can help you plan for your cash inflows and outflows over 12 months)
• accounts receivable – money that’s owed to you in the short-term, for example outstanding invoices that you’ve sent to customers and clients
• inventory – your stock, items, and works-in-progress that you’ll be selling to customers (you have to own these already)
• temporary investment – short-term investments that you can easily convert into cash (equities aren’t included here, because their value fluctuates often)
• prepaid expenses – including rent, energy, and business insurance

Fixed assets and long-term assets. These can depreciate in value and also include items you own that aren’t tangible, like intellectual property and customer goodwill (your business’s reputation).

Fixed assets include:

• property and equipment – buildings, land, machinery, and equipment (for example computers) that your business owns (be sure not to include equipment as a current asset under inventory – it should go here)
• leasehold improvements – these are changes you’ve made to the commercial property that you rent, including redecorating
• equity and other investments – investments that you can’t convert into cash easily and that fluctuate in value
• less accumulated depreciation – how you estimate assets to lose value over time – for example, if you expect a computer that costs £1,500 to last five years, you can divide £1,500 by five to get a depreciation of £300 a year In our balance sheet template, there’s space to include more assets, including intangible assets like intellectual property.

Halfpoint/stock.adobe.com

Balance sheet example: liabilities

A balance sheet usually includes liabilities on the right side (or the bottom). Like assets, you can break liabilities down into current liabilities and long-term liabilities.

Current liabilities include liabilities like rent and utilities, which are due over the next 12 months, while long-term liabilities include liabilities like loans that are due to be paid after 12 months.

On our balance sheet template, current liabilities include:

• accounts payable/trade creditors – money that your business owes for goods and services
• accrued compensation – money that your business owes for goods and services that you haven’t received, and that you haven’t been invoiced for yet
• income taxes payable – money that you owe for taxes
• unearned revenue – money received from a customer or client for work that your business hasn’t done yet
• any other liabilities – current liabilities that don’t fall under the above categories

Long-term liabilities include:

• mortgage – long-term loans for land or property that your business owns
• other long-term liabilities – these could include deferred tax payments and other liabilities that you don’t need to pay back for at least 12 months

Balance sheet example: shareholders’ equity (or simply owner’s equity)

This part of the balance sheet goes below the liabilities section. It refers to the amount of money generated by a business – your net assets.

The balance sheet formula for this section is:

Shareholders’ Equity = Total Assets – Total Liabilities

On our balance sheet template you can see under this section:

• capital stock – shares that a company has and can sell (essentially this is a liability, because this is what the business would owe to its owners if the business was sold)
• retained earnings – income that’s been kept by the business rather than distributed to owners

If you’re a sole trader or unincorporated business, you might be wondering what shareholders’ equity means for you. It essentially represents how much you’ll be left with if you decide to stop trading, sell your business assets, and pay off your business liabilities. Our article on equity in business has more information.

In this case, capital stock is the money you paid into the business to set it up, before you started making money. Retained earnings is effectively ‘the rest’ – the money the business has made while it’s been operating that hasn’t gone into things like paying bills or buying materials. This can be paid out to the sole trader.

Creditors and debtors – what do you need to know?

As a small business you can be both a creditor and debtor. For example, you can have debtors to your business (customers), making you the creditor.

At the same time, you can be a debtor to another business (such as a supplier), in which case they’re the creditor.

It’s important to understand what these terms mean when filling out the assets and liabilities sections of your balance sheet.

What is a debtor?

The debtors meaning is: any business or individual that owes money to a business because they’ve been provided with a service or product, or borrowed money from another business or individual.

If your business borrows money from a bank to hire more staff you become a debtor to the bank, which is the creditor.

When you buy the supplies you need to run your business, you become a debtor to the supplier.

If a customer hasn’t paid an invoice and owes you money, then they’re a debtor to your business. All the money you’re owed by customers for a product or service you’ve provided is known as trade receivables.

What is a creditor?

The creditors meaning is: any business that’s owed money because they’ve provided a service or product, or lent money to another business or individual.

When a bank lends money to a small business, the bank is known as a loan creditor.

Suppliers to other businesses are known as trade creditors. For example, a coffee bean producer that supplies its beans to a coffee shop would be a trade creditor.

It’s not uncommon for small businesses to be creditors but also owe money to other creditors.

What do debtors and creditors mean for your balance sheet?

It’s important to record details of your business’s debtors and creditors on your balance sheet.

All the money you owe to creditors should go on the liabilities section of your balance sheet, while the money you’re owed by debtors can be considered assets.

Although being owed money can be considered an asset, late payments can cause financial issues for small businesses.

On top of this, you could encounter problems if you have a significant amount of debt owed to creditors on your balance sheet.

Balance sheet and statutory accounts

If you run a limited company, your balance sheet forms part of your annual (statutory) accounts. These need to meet accounting standards, so you should speak to your accountant or tax adviser – you won’t be able to use our balance sheet template.

Read more about preparing statutory accounts for your limited company.

More useful guides for small business owners

• How to budget: a budget calculator and guide for the self-employed
• Cost of living support for small businesses and the self-employed
• What is asset finance?
• What type of business insurance do I need?

Do you use a balance sheet to understand the health of your business? Let us know in the comments below.