Finance fundamentals
How to Read a Balance Sheet
A balance sheet has three sections: Assets (what the business owns), Liabilities (what it owes), and Equity (the difference — what belongs to the owners). The equation Assets = Liabilities + Equity must always balance. Read it at a snapshot date, not over a period like an income statement.
The balance sheet is one of three core financial statements (along with the income statement and cash flow statement). It answers: "How financially healthy is this business right now?"
The balance sheet equation
Assets = Liabilities + Equity
This equation must always hold. If a business has $500,000 in assets funded by $200,000 in loans and $300,000 from owners, the balance sheet shows: Assets $500,000 = Liabilities $200,000 + Equity $300,000.
Section 1: Assets
Assets are everything the business owns or is owed. Listed in order of liquidity — most liquid first (cash), least liquid last (equipment, real estate).
| Asset | Type | Example |
|---|---|---|
| Cash & cash equivalents | Current | $25,000 in checking/savings |
| Accounts receivable | Current | Unpaid customer invoices |
| Inventory | Current | Products ready to sell |
| Prepaid expenses | Current | Prepaid insurance, rent deposits |
| Property & equipment | Long-term | Building, machinery, vehicles |
| Accumulated depreciation | Long-term | Offsets PP&E (negative) |
| Intangible assets | Long-term | Patents, trademarks, goodwill |
Current assets = convertible to cash within 12 months. Long-term assets = held for more than one year.
Section 2: Liabilities
Liabilities are everything the business owes — to suppliers, lenders, employees, and the government. Also split into current (due within one year) and long-term.
| Liability | Type | Example |
|---|---|---|
| Accounts payable | Current | Unpaid supplier invoices |
| Short-term debt | Current | Line of credit, current portion of loans |
| Accrued expenses | Current | Wages owed, taxes owed |
| Deferred revenue | Current | Paid subscriptions not yet earned |
| Long-term loans | Long-term | SBA loan, mortgage |
| Deferred tax liabilities | Long-term | Tax differences from depreciation |
Section 3: Equity
Paid-in capital
Money invested by owners. If you put $50,000 of your own money into the business, that's paid-in capital.
Retained earnings
Cumulative profits kept in the business (not paid out to owners). Grows with net income, shrinks with distributions and losses.
Total equity
Total Assets − Total Liabilities. The book value of the business. Growing equity over time = the business is building wealth.
Key ratios to calculate from a balance sheet
Current Assets ÷ Current Liabilities
1.5–2.0 is healthy; below 1.0 means you owe more in the next year than you have liquid
Current Assets − Current Liabilities
Positive = can cover short-term obligations; negative = potential cash crisis
Total Liabilities ÷ Total Equity
Below 2.0 preferred by most lenders; highly capital-intensive industries run higher
Total Liabilities ÷ Total Assets
Below 0.5 (50%) = most assets are equity-financed; above 0.8 = high leverage
Frequently asked questions
What is a balance sheet?+
A balance sheet is a financial statement that shows a business's financial position at a specific point in time. It lists assets (what the business owns), liabilities (what it owes), and equity (the difference — what's left for owners). The fundamental equation: Assets = Liabilities + Equity. It must always balance.
What are the three sections of a balance sheet?+
1. Assets: Everything the business owns or is owed — cash, accounts receivable, inventory, equipment, property. Split into current assets (convertible to cash within one year) and non-current/long-term assets. 2. Liabilities: Everything the business owes — accounts payable, loans, credit card balances, deferred revenue. Split into current (due within one year) and long-term. 3. Equity: Also called shareholders' equity or owner's equity. Equity = Total Assets − Total Liabilities. It includes retained earnings (accumulated profits) and paid-in capital.
What is the balance sheet equation?+
Assets = Liabilities + Equity. This equation must always balance — hence the name. If a business has $500,000 in assets and $200,000 in liabilities, equity must be exactly $300,000. If assets grow (e.g., you buy equipment), either liabilities must increase (you took a loan) or equity must increase (you used retained earnings or owner investment).
What is working capital on a balance sheet?+
Working capital = Current Assets − Current Liabilities. It measures short-term liquidity — whether you have enough to cover near-term obligations. Positive working capital means you can pay your bills. Negative working capital is a red flag (you owe more in the next 12 months than you have in liquid assets). A current ratio (Current Assets ÷ Current Liabilities) of 1.5-2.0 is generally healthy.
What is retained earnings on a balance sheet?+
Retained earnings is the cumulative net income your business has kept (not paid out as dividends) since it was founded. It appears in the equity section. Growing retained earnings = the business has been profitable over time and reinvesting. Retained earnings increase with net income and decrease with distributions/dividends or losses.
What is the difference between a balance sheet and an income statement?+
A balance sheet is a snapshot of financial position at a specific date (what you own and owe RIGHT NOW). An income statement covers a period of time (revenue and expenses over a quarter or year — the flow). They connect through retained earnings: net income from the income statement increases equity on the balance sheet each period.
What is the debt-to-equity ratio?+
Debt-to-Equity = Total Liabilities ÷ Total Equity. It measures how much of the business is financed by debt vs. owner investment. A ratio of 1.0 means equal debt and equity financing. Higher ratios mean more leverage (riskier, but can amplify returns). Most lenders prefer D/E below 2.0 for small businesses. Very capital-intensive industries (real estate, manufacturing) often run higher ratios.
How do you calculate a company's book value?+
Book value = Total Assets − Total Liabilities = Total Equity. It represents the net worth of the business according to its accounting records. Book value per share = Equity ÷ Number of shares outstanding. Market value often differs significantly from book value — market value reflects future earnings expectations, while book value reflects historical cost minus depreciation.
Related guides and tools
Revenue, COGS, gross profit, and net income — the income statement explained.
Accounts receivable vs accounts payable — what's the difference?
Which accounting method recognizes revenue and expenses correctly for your business.
Calculate working capital and current ratio from your balance sheet numbers.
Estimate your business value using revenue and earnings multiples.
Warning signs to look for when reviewing business financials.