As a small business owner, you’ve heard you need to ‘know your numbers’.
That’s fine, but where do you need to look on your balance sheet to find them? And do you know what the important bits are?
That’s why understanding your business balance sheet is so important. This article will give you:
- A basic idea of what a balance sheet is
- Why it’s important
- The top-level information you need to know
You will probably only have access to a balance sheet on a regular basis if you keep your records in an accounting app such as Xero or QuickBooks. You may also see a balance sheet as part of your year-end accounts, or more regularly if you pay to have ‘management accounts’ completed.
Remind me – what is a balance sheet?
A balance sheet is simply a document that shows the financial position of your business at any given moment in time.
You may be more familiar with your Profit & Loss report which is effectively a list of your income and expenses. However, a balance sheet is arguably more important as it can show you:
- The overall ‘health’ of your business
- Who you owe money to (and if done correctly, now and in the future)
- Who owes you money
- What you ‘own’ (your business assets)
- Your cash balances
- Money available to you as the business owner (on paper at least!)
One of the coolest things a balance sheet can show you is what (roughly) would be left to you if you closed the business down today and walked away (putting aside any potential monies raised in a sale).
What a balance sheet looks like
Here’s one we made earlier:
How to read a balance sheet in 4 easy steps
STEP 1 – Balances
First, read the document and look at the balances shown next to each item. This will quickly give you a sense of whether you think the book-keeping is right. Gut instinct is good here!
- Does this balance feel correct? One of the easiest to check is your bank balance.
- Is the end balance the wrong way round? If so, do you have any items listed under ‘Assets’ that are in negative figures? Make time to investigate further.
STEP 2 – The ‘Assets’ section
This area usually includes all the things the company ‘owns’, including cash balances, money it’s owed, etc. Items listed under ‘fixed assets’, ‘plant and machinery’, ‘computer equipment’ etc are usually shown at cost – i.e what you paid for them. (They are not usually shown at market value due to the way the accounting rules work.)
You may also see items like:
- Cash balances.
- Rent deposits you’ve paid.
- ‘Prepayments’ – this is an accounting adjustment to take into account that some items you may have bought are related to the period in question. Don’t sweat this!
- Taxes owed to you, such as Construction Industry repayments, VAT refunds, etc.
- Balances owed to you from any other companies or employees, for example, if you loaned them money.
- If you owe your limited company money. This could show as a Directors Loan account that’s the ‘wrong way round’.
It’s always interesting to look at what makes up the item known as ‘Accounts Receivable’ or ‘Trade Debtors’. This balance is the amount of money owed to the business by its customers or clients at that moment in time.
Most accounting software apps allow you to pull up a report just on this item. This will show you what the book-keeping records say you are owed per client/customer. (If you are looking at accounts someone has prepared for you, ask them for a breakdown.)
In our example balance sheet above, the demo company is owed £1451. Once you as the owner know this figure, you can decide action to take, such as:
- Chasing the invoices
- Writing them off
- Correcting and/or updating the book-keeping(!)
STEP 3 – The ‘Liabilities’ section
This area could be seen as the ‘bad stuff’. Your Liabilities number is the total amount of money you owe to various parties, both now and in the foreseeable (known) future. This might include:
- Corporation Tax owed
- Provisions for future corporation tax
- VAT owed
- Money owed to you as the director (limited company only)
- Money owed to your suppliers
- Loans you owe
- Finance agreement balances
It’s important to realise that for a lot of these items, you don’t actually owe this money right now. It’s a snapshot of what is technically someone else’s money at that moment in time.
Sometimes balances owed to bank or other loans might not exactly match your statement at a given time. This is because of the way the accounting rules work with the way interest has to be calculated.
Again, don’t sweat this. Just make sure you understand when each of these liabilities is actually due, to ensure you have the relevant cash to hand.
STEP 4 – The Equity Section (the ‘bottom bit’).
One key figure in this section is the Owner’s Drawing (if sole trader) or ‘Dividends Paid’ (if a limited company). This figure gives you a feel for how much money you or other owners have drawn out in the period.
Again, if it doesn’t feel right – dive into those balances! Accounting applications almost always let you click into a balance on a report and start digging into the detail.
If you are looking at a set of static (printed) accounts , speak to whoever did them to fully understand what makes up those balances.
The final bottom figure, often shown as ‘Shareholders Funds’ or ‘Total Capital and Reserves’, is a strong indicator of the health of your business. You really don’t want number to be negative! If it is, seek advice to understand why this is, what it means and what you should do about it.
In learning about, reading and understanding your business balance sheet for the first time, you really are training to gain! Benefits include:
- An awareness of what is going on in your business in terms
- A sanity check that the figures ‘feel’ right and/or the book-keeping is correct
- Some actionable information, such as who owes you money
I’m still confused about balance sheets
Ask your accountant to talk you through it, and how it will impact on your business. The information on your balance sheet will also help you make informed business decisions and help with financial planning for the future.
If you don’t have an accountant, or feel you aren’t making the most of your balance sheet with your current accountant, we’d love a chat about how we can help.