How to Read Your Balance Sheet
If reading your balance sheet makes your eyes glaze over or inspires the same dread as opening a letter from the IRS… don’t worry, you’re not alone. The good news? A balance sheet isn’t as scary as it looks and once you know how to read it, it becomes a superpower for your business.
I’ve been a bookkeeper for years, and trust me your balance sheet, paired with your profit and loss statement (P&L), are the two MVP’s of financial reporting. Every business owner should know how to read them and review them regularly. (If you haven’t checked out my “How to Read Your P&L” blog series yet, you can catch up with part one of that here).
So, grab your favorite beverage, and let’s break down this wonderful tool, the balance sheet, one section at a time.
First though…. What Is a Balance Sheet?
Think of a balance sheet as a snapshot of your business’s financial health at a single point in time. It tells you if your business is actually running on it’s own, or if it’s just surviving off caffeine and good intentions. Lenders, investors, and even you, use it to understand how strong (or fragile) your business really is.
It shows three key things:
What you own (Assets)
Think: cash, inventory, equipment, accounts receivable (aka money people owe you but haven’t paid yet).
What you owe (Liabilities)
Loans, unpaid bills, credit card balances (this is the “reality check” section).
What’s left over for you (Owner’s Equity)
This is “your slice of the pie” (and hopefully it is not showing an “IOU”).
The report brings it all together in a simple balancing formula:
Assets = Liabilities + Owner’s Equity
Everything balances (nothing clever here, it is named Balance Sheet for a reason) and with love from your favorite accountant: balancing is non-negotiable…. save the chaos for your inbox 🫠.
How to Read a Balance Sheet Like a Pro:
1. Start with the Assets (a.k.a. the stuff that makes the business look good)
Assets are everything your business owns that has value. So if you can slap a price tag on it, it’s an asset. This includes the obvious things like cash in the bank, inventory, and equipment, as well as less obvious items like money your customers still owe you. In bookkeeping, we usually split assets into two main categories:
Current Assets – cash, accounts receivable, inventory, etc. These tend to change day-to-day, affect your cash more frequently, move with your P&L, and aren’t the big long-lasting purchases (like a car). Think of them as the booster shots of your business: small, frequent, and keeping everything running as they should.
Fixed Assets – these are the big-ticket items that are usually over $2,000. Anything less than that is typically considered an immediate expense and shows up on your P&L. These assets also stick around for more than a year (your tax accountant will have the final word on this, based on what will be in your best interest, but this is a solid starting point). Basically, if it’s pricey and not going anywhere soon (like those new Amazon electric vehicles that still bring our packages late - I love you Amazon but sometimes😑), it belongs here. If it’s cheap and fleeting, it’s partying on your P&L.
This number shows lenders and potential buyers the “sticker price” of your company before factoring in any debt. In other words, if they took over tomorrow, it’s what they could reasonably sell the business stuff for without having to dig into their own pockets to cover your bills. Think of it as the showroom value…before anyone pops the hood and sees what’s owed.
Bookkeeper Tip: Start by looking at Cash. If it’s consistently low, you might be profitable on paper but broke in real life (yikes).
Extra Bookkeeper Tip (look at that, two for the price of one): Check your Accounts Receivable, slow payers equal slow cash flow. Think of it like giving your customers an interest-free loan... fun for them, not so much for you when you’re still footing the bill for the raw materials, payroll, etc. Keep an eye on how long it takes for money to land in your account (patience might be a virtue, but guarantee your employees won’t be very patient to receive a paycheck).
2. Next Up: Liabilities (a.k.a. what you owe)
When you peek at your balance sheet, the liabilities are your company’s financial promises. They show what your company owes to others: think loans, credit cards, and unpaid bills. As long as you do not have too many and are on top of the payments, liabilities aren’t the villain of your financial story; they’re just the obligations that keep your business moving forward.
There are two main types of liabilities:
Current liabilities: These are short-term debts such as accounts payable (like the paint you bought from Bob’s store down the street, who kindly gave you 30 days to pay him for it…thanks, Bob!), taxes 😩, or paying off those credit cards you used to buy the small items that keep your business moving.
Long-term liabilities: Think of these as your business’s big commitments and include mortgages, equipment loans, or the financing for that one machine specifically for the type of work you do that costs a small fortune. Most of the time, these loans correspond to the fixed assets listed on the assets side of your balance sheet (once again bringing the balance in this reports name).
Managing liabilities well is key. Paying attention to what you owe and when helps you avoid late fees, interest, or cash flow headaches. Think of liabilities as a balancing act which can help your business grow if handled wisely, but ignoring them can lead to financial wobbles.
And yes, for accountants, liabilities justify an extra coffee break….or three, while keeping the books neat and tidy.
Bookkeeper liability tip: Plan your cash flow. Regularly review liabilities alongside expected income to ensure your business has enough cash to cover obligations without stress. Remember the principal payments for these do not show up on your P&L (see P&L blog post that further explains that here), so it is important to account for this properly.
3. Now: Equity (what’s really yours)
Equity is what’s left of your business’s value after you subtract everything it owes (liabilities) from everything it owns (assets).
Picture your business as a giant yard sale. You sell every piece of equipment, collect from every person who owes you, and sell every piece of inventory the business stocks (your assets), then use that money to pay off every bill, loan, and IOU (your liabilities). Whatever cash is still in your hand at the end, that’s your equity.
It’s your true ownership stake, the part of the business you can actually call yours. It’s a bit like discovering there’s still a slice of your birthday cake left after everyone else has had a piece. (We’re aiming for good news here, not the nightmare scenario where the cake is gone and someone’s already claimed next year’s cake.)
Common Equity Types:
Owner’s Investment
This is the money you, as the owner, put into your business. Think of that time you had to transfer personal cash into your business account to cover payroll, all because a client decided to treat their invoice like a “suggested due date.”
Owner’s Draw
The opposite of an Owner’s Investment. It’s money you take from your business for personal use, outside of payroll (please do not put yourself on payroll unless you’re business is qualified to allow for this… ask your tax accountant first). Whether you pull cash from the business account or swipe the company card for that irresistible shirt, that’s an owner’s draw.
Retained Earnings
Retained earnings are the profits your business has kept over time with the future in mind. After all the bills are paid and you’ve taken your share, what is left can be tucked away for big opportunities or that “just in case” rainy day fund…. because even businesses need an emergency stash (just like the secret bag of candy I hide in the back of the cupboard so my kids can’t find it).
Bookkeeper Tip: Keep draws and investments clean. For an investment, deposit personal money into the business account, so the company pays for it’s own bills and payroll. Avoid using personal funds to pay the business expenses directly, it can be easily forgotten and could cost you tax deductions. Likewise, take draws by moving cash from the business to your personal account before buying that irresistible shirt, keeping your taxes tidy and audit-proof.
Extra Extra Tips Just For You
Compare Periods: Look at trends month-to-month or year-to-year. That’s where the story is.
Reconcile Your Account Regularly (best practice is monthly): If your accounts aren’t reconciled, your balance sheet may be telling tall tales.
Watch for Uncategorized Accounts: These are mystery line items, which just mean that something is not where it belongs. Clean those up to keep your sheet accurate.
Match Numbers to Reality: If your inventory says $25K but you’re staring at half-empty shelves, it’s time to tally that and make it accurate.
Final Thought
Your balance sheet isn’t just a boring report, it’s a pulse check on your business. It tells a story. And once you learn to read it, you make better decisions.
So next time you pull it up, give it a real look. Your future self will thank you.
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