Understanding Your Balance Sheet

To understand the financial position of your business at a specific point in time, one of the most useful reports to review is the balance sheet, also known as the Statement of Financial Position.

Together with the Profit and Loss Statement and other reports, such as the Statement of Cash Flows, the balance sheet helps provide a complete picture of your business’s financial position and performance.

What does a balance sheet show?

A balance sheet has three main sections:

• Assets
• Liabilities
• Equity

The relationship between these sections is represented by the balance sheet equation:

Assets = Liabilities + Equity

As the name suggests, both sides of this equation must always balance.

What are assets?

Assets are the things and resources a business owns or controls that have current or future financial value.

Depending on the business, assets may be divided into several categories, including:

• Current assets, which are generally expected to be converted into cash within one year
  
  • Bank accounts
  • Accounts Receivables (Trade Debtors)
  • Inventory
  • Prepayments
• Non-current or long-term assets
  
  • Property, Plant & Equipment
  • Intangible assets
  • Investments

What are liabilities?

Liabilities are amounts the business owes to suppliers and other creditors for goods or services it has already received.

They may also include money received in advance for goods or services the business has not yet provided.

Liabilities are generally divided into:

• Current liabilities, which are usually payable within one year
  
  • Creditors / Payables
  • Employee Entitles
  • Taxes
• Non-current liabilities, which are payable over a longer period
  
  • Loans

What is equity?

Equity represents the owner’s interest in the business and comprises Capital Investment, Accumulated Profits and Capital Gains.

Equity is calculated as:

Equity = Assets − Liabilities

Transactions affecting your Profit and Loss Statement can also affect the balance sheet. For example, providing a service on credit increases accounts receivable and, through the income earned, increases equity.

How does the balance sheet equation work?

Imagine your business purchases a vehicle for $50,000. You pay a $10,000 deposit from the business bank account and borrow the remaining $40,000.

The transaction affects the balance sheet as follows:

• Fixed assets increase by $50,000
• Cash decreases by $10,000
• Liabilities increase by $40,000

The net increase in assets is therefore $40,000, matching the $40,000 increase in liabilities. The balance sheet remains balanced.

Does equity show what your business is worth?

Not necessarily.

The equity shown on your balance sheet provides an accounting view of the business’s net assets at a particular date. However, it does not necessarily represent how much the business could be sold for.

Assets are generally recorded using accounting values, which may differ significantly from their current market values. Some assets may have increased in value, while others may have depreciated. A business valuation also considers factors that may not be fully reflected on the balance sheet, such as profitability, future earnings, customer relationships and goodwill.

Get the complete picture

Your balance sheet provides valuable insight into what your business owns, what it owes and the owner’s interest in it. When reviewed alongside your Profit and Loss Statement and

Statement of Cash Flows, it can help you better understand your business’s overall performance and financial position.

Need help understanding what your financial reports are telling you? Talk to the Munro Benge team—we’re here for the conversation.

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