How to Read a Balance Sheet for Your Small Business

The three parts

Assets are what you own, liabilities are what you owe and equity is the difference. Assets always equal liabilities plus equity.

Assets are listed from most liquid (cash) to least (equipment, property). Liabilities are listed by due date, with short-term bills first. Equity shows owner investment and retained earnings. The structure comes from the accounting equation. For more on the three categories, see assets, liabilities and equity.

An illustrative balance sheet

A business with $120,000 in assets, $70,000 in liabilities and $50,000 in equity balances: 120 = 70 + 50.

Check short-term safety

Compare current assets with current liabilities. In the example, $70,000 of current assets covers $30,000 of current liabilities more than twice.

Current assets here are cash, receivables and inventory ($70,000). Current liabilities are payables and card and tax balances ($30,000), plus the current portion of the loan if there is one. The ratio is the current ratio. A stricter test drops inventory: see the acid-test ratio.

Check long-term leverage

Compare total liabilities with equity. In the example, $70,000 of liabilities against $50,000 of equity gives a debt-to-equity ratio of 1.4.

A higher ratio means the business depends more on borrowed money. What is acceptable depends on your industry and cash flow. Read how to calculate debt-to-equity.

Watch trends, not just one date

Compare balance sheets from several months. Rising receivables, falling cash or growing debt are early warning signs.

One balance sheet is a photo. Several are a film. If receivables climb faster than sales, customers are paying slower. If payables climb while cash falls, you may be leaning on suppliers for funding. Pair the balance sheet with the income statement and the cash flow statement.

Making sure it is right

A reliable balance sheet needs reconciled bank and card accounts, accurate receivables and payables, and correct inventory and equipment values.

Reconcile every cash account monthly. Clean up old receivables you will not collect. Record depreciation. Ask your accountant to review the balance sheet at least once a year.

Common balance sheet red flags

Negative cash, growing old receivables, shrinking equity and loans with no clear purpose are signals to investigate.

• Receivables growing much faster than sales.
• Inventory rising while sales are flat.
• Large owner loans or draws that erode equity.
• Payroll taxes or sales taxes owed for many months.
• An account called 'suspense' or 'ask my accountant' with a large balance.

None of these is automatically fatal. Each is a question to answer, preferably with your accountant, before it becomes a crisis.

How often to review and who should see it

Review the balance sheet monthly yourself, and share it with your accountant at least quarterly and with any funder who asks.

Set a monthly appointment to read it alongside the income statement. Write down three observations each time: what changed, why, and what you will do. Your accountant can point out items that look unusual, such as an old receivable or a loan classified in the wrong place. Keep each month's report saved as a PDF so you can compare trends later and answer questions quickly when they come up.

How it relates to getting funded

Funders of working capital focus mostly on cash flow, but a healthy balance sheet widens your options and helps you choose the right product.

ROI Funder reviews an application plus 3 months of business bank statements, and considers 500+ FICO, 6+ months in business and $20,000+ monthly revenue. If your balance sheet shows seasonal swings in cash, a business line of credit may fit. For equipment, see equipment financing.