What is a balance sheet?

The balance sheet is one of the statements every business prepares at the end of each financial year. It’s a snapshot of the business’s assets, liability, and equity on a specific date.​

While a profit and loss account is considered the most important financial statement (because it shows the profit), the balance sheet can reveal other relevant information.​

A business may seem to be profitable, but the balance sheet may indicate otherwise:​

Anybody asking for a business’s profit and loss account will also want to see the balance sheet. They go hand-in-hand:​

This financial statement acts like a snapshot of your business’s assets, liabilities and equity at a specific date. That information can be used in conjunction with your profit and loss account to calculate income tax, meet legal requirements and spot opportunities to optimise.​​

These are items belonging to the business, which we split into the categories current and non-current.​​

We class current assets as those likely to be converted into cash within 12 months of the balance sheet date. It means the value shown in the balance sheet is likely to match the eventual cash the business will receive.​​

These assets are used to carry out business activities or generate interest or dividends for the company. They aren’t expected to be converted into cash within 12 months (though, they can be).​​

While their value is recorded at their original purchase price, it’s important to keep in mind that that isn’t necessarily what they’d be worth if they were to be sold. For example, vehicles and machinery decrease in value over time, and land values can increase.​​

A liability is money you owe to another person or organisation. As with assets, we separate these into current and non-current.​​

Current liabilities are expected to be paid within 12 months of the balance sheet date.​​

Non-current liabilities don’t usually require payment within the next 12 months. The most common type of non-current liability is a long-term loan.​​

The equity is what you might call the balancing figure and it represents the ultimate value of the business to its owners.​​

Equity = assets - liabilities​

Within equity, retained earnings is the most interesting figure. It represents the profits from previous years that have been kept in the business, rather than paid out to shareholders.​​

It’s possible for equity to become negative – when liabilities exceed assets. Such situations are an indicator of insolvency – the business’s ability to continue operating. If this applies to you now or appears likely in future, we urge you to seek professional advice. There can also be serious legal consequences for continuing to trade while insolvent.​​

We treat a balance sheet like a snapshot of asset’s liabilities and equity on a specific date. Let’s see what it can look like at 31 March 2021:​​

Bank account – $3,000
House – $782,000
Total assets – $785,000​​

Credit card balance – $1,000
Mortgage – $523,000
Total liabilities – $524,000​​

Net worth – $261,000 ($785,000 less $524,000)​​

On 1 April 2021, you borrow $4,500 to purchase a vehicle. The asset and the loan will not be included in the balance sheet at 31 March – they didn’t exist at that date (for you). On 1 April 2021 your assets and liabilities would both increase by $4,500.​

On 31 October 2021, you have an unconditional agreement to sell the house for $825,000; settlement will take place on 30 November 2021. At 31 October 2021, your equity has increased by $40,000 ($825k less $785k), and is now $301k. The $40k increase doesn’t mean your equity at 31 March was incorrect – it’s just that we’re recording the value of the asset at a different date​