Most owners read the profit and loss and skip the balance sheet. That is understandable: the profit and loss tells a story about the month, while the balance sheet looks like a list. But the balance sheet is where problems in the books show up first.
Here is how to read one in about five minutes, with an example from a small service company.
The short answer: a balance sheet shows what a business owns (assets), what it owes (liabilities), and what is left for the owners (equity) on one date. The two sides always balance: assets equal liabilities plus equity. To read it, check cash, money customers owe you, what you owe, loan balances, and how equity changed.
The one-line version
What you own = what you owe + what’s left for the owners.
In accounting words: assets equal liabilities plus equity. The two sides always balance. If yours don’t, something in the books is wrong.
The three sections
1. Assets: what the business owns
Cash in the bank, money customers owe you (accounts receivable), and things the business owns, such as equipment and vehicles, recorded at their cost less wear over time.
2. Liabilities: what the business owes
Credit card balances, bills you haven’t paid yet (accounts payable), payroll taxes waiting to be paid, and loans, including vehicle and equipment loans.
3. Equity: what’s left for the owners
Money the owners put in, profits kept in the business over the years (retained earnings), this year’s profit so far, and money the owners took out (draws or distributions).
A small business balance sheet example
Here is a simplified balance sheet for a small service company on December 31. The numbers are round on purpose.
| Line | Amount |
|---|---|
| Assets | |
| Cash in the bank | $42,000 |
| Accounts receivable (customers owe you) | $18,000 |
| Equipment and vehicles, less wear | $65,000 |
| Total assets | $125,000 |
| Liabilities | |
| Credit cards | $4,000 |
| Accounts payable (bills not yet paid) | $6,000 |
| Payroll taxes owed | $3,000 |
| Vehicle loan | $37,000 |
| Total liabilities | $50,000 |
| Equity | |
| Owner’s investment | $10,000 |
| Retained earnings from past years | $40,000 |
| This year’s profit | $45,000 |
| Owner draws this year | -$20,000 |
| Total equity | $75,000 |
| Total liabilities and equity | $125,000 |
Reading the example
- It balances. Total assets ($125,000) equal total liabilities plus equity ($50,000 plus $75,000).
- Cash covers what is due soon. $42,000 in the bank against $13,000 in cards, bills, and payroll taxes.
- Customers owe $18,000. Worth a look at how old those invoices are.
- The vehicle loan is the biggest debt. Its balance should go down every month as it is paid.
- The owner took out $20,000 of this year’s $45,000 profit, and the rest stayed in the business.
Try it
Does your balance sheet balance?
Change any number to see the scale move.
What to check each month
- Cash: does the bank balance match your bank statement for the same date?
- Accounts receivable: are the unpaid invoices real, and how old are they?
- Credit cards: do the balances match the card statements?
- Loans: do the balances match the lenders’ statements, and are they going down as you pay?
- Equity: are owner draws recorded here, and not hidden in expenses?
Warning signs
- A negative bank balance when the bank says you have money.
- Uncategorized amounts sitting in an asset or liability account.
- Accounts receivable full of invoices from many months ago.
- A loan balance that never changes, because whole payments are being recorded as an expense.
- Payroll liabilities that keep growing.
Any of these means the profit and loss may be off too, since the two reports are built from the same entries.
Balance sheet vs income statement
The income statement, also called the profit and loss, shows how a period went: income, costs, and profit for the month or year. The balance sheet shows where things stand on one day. The cash flow statement connects the two by showing where the cash went. Read together, they explain why a profitable month can still leave less in the bank.
Frequently asked questions
Start with the equation: what you own equals what you owe plus what’s left for the owners. Then check five lines: cash, money customers owe you, what you owe, loan balances, and equity.
Whether the business can cover what it owes, how much customers owe it, how much debt it carries, and how much of the profit has stayed in the business over time.
Partly. The equity section shows this year’s profit as one line, but the profit and loss shows how that profit was earned. Read them together.
Profit can be tied up in unpaid invoices, equipment, or loan payments. The profit versus cash guide walks through it.
The profits the business has kept over the years, after owner draws. QuickBooks Online moves each year’s net income into it at the start of the new year.
Start with a conversation
Our monthly clients receive a profit and loss and a balance sheet on an agreed schedule, and we walk through them together. If you’d like that, request a free consultation. Prefer to call? 781-924-1489.