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Posted In: Business Planning

What Is the Purpose of a Balance Sheet?

The balance sheet provides a snapshot of a company’s assets, liabilities, and equity at the end of an accounting period. These three categories allow business owners and investors to evaluate the overall health of the business, as well as its liquidity, or how easily its assets can be turned into cash.  

Why is it called a balance sheet?

The core of the balance sheet is the accounting equation:

Assets = Liabilities + Equity

Unlike other reports which show performance over a specified period, the balance sheet is a snapshot of your company showing what the company owns versus owes at a specific moment in time. The assets show everything the company controls, and the liabilities and equity sections show who currently owns those assets—the company (equity) or someone else (liabilities).  

If your total assets do not equal your liabilities and equity, the balance sheet is considered “unbalanced.”

What is included in the balance sheet?

The balance sheet is split into two sections, reflecting both sides of the accounting equation.

The first section lists all assets, which includes anything the company possesses, whether or not they own it. Assets are generally placed in order of liquidity, with the assets that can be most easily converted into cash at the top of the list (Cash, A/R, etc.) and things like property and equipment at the bottom. At the bottom of this section, all assets are added up to a Total Assets calculation.

The second section includes liabilities and equity. The liabilities portion shows everything that the company owes to other people with line items like accounts payable, credit card balances, and loans. All liabilities are then added up and shown as a sub-total.

The equity portion shows the assets that the company owns outright. If you were to sell all your assets and pay off your liabilities, the owner’s equity would be the money that is left. Most commonly what is held here are monetary investments into the company that do not have any stipulations to pay back. For small business owners, personal equity and distributions made by the company live here. The sub-totals of the liabilities and equity portions are then added to show the Total Liabilities & Equity.

The Total Assets must match the Total Liabilities & Equity exactly.

What Is Not Shown on The Balance Sheet?

The balance sheet does not show performance. That is what the income statement, which lists income and expenses over a certain period, is for. The income statement shows you how much money you brought in and spent, and tells you whether you made or lost money over that period. However, at the end of your fiscal year, your net income or loss is rolled into retained earnings.

Also not shown in the balance sheet is cash flow. The assets section lists cash totals, but it does not show the cash brought in over the previous period or the cash spent. The cash flow statement is essentially a deeper dive into the first line item of the balance sheet and can help business owners and investors better understand the company’s liquidity and ability to pay off liabilities in future months.

Overall, the main element missing from a balance sheet is time. Remember, it’s a snapshot—a picture of your company’s health in a specific moment. It is not meant to show change over a period the way income statements and cash flow statements do.

Tips for Reading a Balance Sheet At-a-Glance

If a balance sheet doesn’t show change, what does it show? The short answer is ratios.

You can easily compare different sections of the balance sheet to one another to calculate ratios that you can track over time. For example, you can divide total liabilities by total equity to see your debt-equity ratio. You can also divide current assets by current liabilities (the short-term assets and liabilities that are listed first) to see the current ratio, or a measure of how likely you are to pay off short-term liabilities.

There are many financial ratios you can examine using the balance sheet. Over time, you will discover which are the most important for your company to track.

Sample Balance Sheet