How to read a balance sheet

Your profit and loss statement tells you how the business performed over a period. Your balance sheet tells you where it stands on one day. business.gov.au says it shows your assets and liabilities “on a particular date”, so you can find out your net assets.

Many owners never look at theirs. That is a missed opportunity, because it answers questions the P&L can’t, such as how much you owe and whether you can pay what is due this year.

The three parts of a balance sheet

Assets: what the business owns

business.gov.au defines assets as “things you own”, such as cash or things you can convert into cash, like property, vehicles, equipment or stock. Money customers owe you (debtors, or accounts receivable) is also an asset.

Liabilities: what the business owes

Liabilities are amounts the business owes to others. Common examples are supplier bills (creditors, or accounts payable), GST and PAYG withholding owed to the ATO, wages and super owed, credit cards and loans.

Equity: what is left for the owners

Equity is the owners’ stake in the business. business.gov.au describes it as the value of ownership interest, calculated by deducting liabilities from assets. It is also called net assets.

• Equity = total assets minus total liabilities

Another way to write the same thing is: assets = liabilities plus equity. That is why it is called a balance sheet: both sides always balance.

Equity usually includes the money the owners put in (for a company, share capital) plus profits kept in the business over the years (retained earnings). Losses and money taken out by the owners reduce it.

Current and non-current

Each side of the balance sheet is split by timing.

• Current assets are cash, or things you expect to turn into cash within 12 months: bank balances, money customers owe you and stock.
• Non-current assets (business.gov.au calls them fixed assets) are things you keep and use for longer, such as vehicles, equipment, fit-out and property.
• Current liabilities are amounts due for payment within 12 months: supplier bills, tax owed, wages and super owed, credit cards and the part of any loan due in the next year.
• Non-current liabilities (or long-term liabilities) are amounts due after 12 months, such as the later years of a loan.

The split matters because you pay this year’s bills with this year’s cash, not with a van you still need.

Worked example

An Adelaide plumbing company with about $900,000 in yearly sales. This is its balance sheet on 30 June.

Assets	Amount
Cash in the bank	$35,000
Customers who owe money (debtors)	$65,000
Stock of parts and fittings	$20,000
Total current assets	$120,000
Vans and tools (after depreciation)	$90,000
Total non-current assets	$90,000
Total assets	$210,000

Liabilities	Amount
Supplier bills (creditors)	$30,000
GST and PAYG withholding owed to the ATO	$15,000
Wages and super owed	$10,000
Vehicle loan, part due within 12 months	$15,000
Total current liabilities	$70,000
Vehicle loan, part due after 12 months	$40,000
Total non-current liabilities	$40,000
Total liabilities	$110,000

Equity	Amount
Share capital	$10,000
Retained earnings	$90,000
Total equity	$100,000

Check the balance: total assets of $210,000 minus total liabilities of $110,000 is $100,000, which equals total equity. Liabilities of $110,000 plus equity of $100,000 is $210,000, which equals total assets.

What an owner can take from this:

• Short-term position. Current assets of $120,000 cover current liabilities of $70,000, with $50,000 to spare. The difference between the two is working capital, which the working capital guide explains in full.
• How much is actually cash. Only $35,000 of the $120,000 is cash. The company needs customers to pay the $65,000 they owe to meet its bills comfortably. $15,000 of its cash is effectively owed to the ATO already.
• How it is funded. The business owes $110,000 and the owners’ stake is $100,000. For every $1 of equity, it owes about $1.10.
• What has been built up. Retained earnings of $90,000 show profits kept in the business over time.

What the balance sheet can tell you

• Can you pay your short-term bills? Compare current assets with current liabilities. A simple ratio many people use is the current ratio: current assets divided by current liabilities. In the example it is $120,000 divided by $70,000, or about 1.7.
• How much do you owe compared with what you own? Total liabilities divided by equity gives a debt-to-equity figure. A rising figure means more of the business is funded by others.
• Is money tied up? Large debtors or stock balances compared with your sales can mean cash is stuck. The lesson on debtors and creditors covers this.
• Is the business building value? Growing equity over several years usually means profits are being kept in the business.

business.gov.au notes the balance sheet can help you work out your working capital needs and your liquidity, meaning how quickly you could pay your current debts.

What changes may indicate

Compare this year’s balance sheet with last year’s, on the same date.

• Debtors growing faster than sales. Customers may be paying more slowly.
• Stock growing faster than sales. You may be over-ordering or holding slow-moving stock.
• Tax or super owed rising. A warning sign. Money set aside for the ATO may be going on other bills.
• Loans or credit cards rising while cash falls. The business may be borrowing to cover running costs, not to buy assets.
• Equity falling. The business is making losses, or the owners are taking out more than it earns.

Where to find it

Your accounting software can produce a balance sheet for any date. Your accountant usually prepares one at the end of each financial year with your profit and loss statement. business.gov.au has a free balance sheet template, and its financial health checklist suggests reviewing your balance sheet alongside your P&L, cash flow statement and budget.

A balance sheet is only accurate if your records are. Old debts that will never be paid, stock that can’t be sold and equipment recorded at more than it is worth all make the business look stronger than it is.

When to talk to an accountant or bookkeeper

• The balance sheet doesn’t balance, or bank balances on it don’t match your bank statements.
• Equity is negative or falling year after year.
• Amounts owed to the ATO keep growing.
• You don’t understand an item, such as a loan to or from a director or a “suspense” account.

A bookkeeper can reconcile the accounts so the figures are right. An accountant can explain what they mean for your business and structure.

Where this matters for business finance

If you apply for finance, a lender will usually ask for your balance sheet as well as your P&L. It shows what the business already owes, what assets it has and how much the owners have invested. Reading it yourself first helps you see whether more debt fits your business, and whether a problem is better fixed another way. See when borrowing is not the answer.

Important things to know

• It is a snapshot. A balance sheet can look quite different a week later after a big payment or a large customer receipt.
• Book values are not market values. Equipment is usually shown at cost less depreciation, not at what you could sell it for.
• Equity is not cash. A business can have strong equity and very little money in the bank.
• Some cash is not yours. GST and PAYG withholding owed to the ATO are liabilities, even while the money sits in your account.
• Read it with the P&L. Profit explains why equity changes, and the balance sheet shows where that profit went. See profit vs cash flow, or look up terms in the glossary.