Many business owners find the balance sheet the hardest financial document to understand and interpret. This guide offers a simple explanation of the balance sheet, relates it to the profit and loss statement, and explains how you can use it to better manage your business.
Your balance sheet is a snapshot of the health of your business
In simplest terms, a balance sheet is made up of three components:
- What the business owns — its assets.
- What the business owes — its liabilities.
- The overall value of the business (its assets minus its liabilities) – this is known as the owner’s equity (it’s also sometimes referred to as the ‘book value’ of a business).
The purpose of the Balance Sheet, as its name suggests, is to balance these. That’s why the bottom line figures on a Balance Sheet must always match each other. This is known as ‘the accounting equation’: Assets = Liabilities + Owner’s Equity. The simple example below illustrates this: