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Financial literacy
6 min

Everything You’ve Ever Wanted To Know About Balance Sheets: Components, Formula, and Examples

Learn what a balance sheet is, what goes on it, and how to build one for your business.

Published at | Updated:
A small business owner sitting at a desk in his living room and preparing a balance sheet.

Key takeaways

  • Recognize that a balance sheet is a point-in-time snapshot of what your business owns and owes.
  • Remember the balance sheet equation: your assets always equal your liabilities plus shareholders’ equity.
  • Separate your assets and liabilities into current and long-term so you can read your position clearly.
  • Prepare a balance sheet each quarter or at year-end to track your business’s financial health.

Why is a balance sheet important?

A balance sheet matters because it shows exactly what your business owns and owes at a single point in time. That snapshot helps owners, employees, and investors judge financial health.

When reviewed internally by the business owner, employee, or accountant, it’s meant to show how well a business is doing on revenue. This data helps inform changes in policies or approaches moving forward.

When reviewed externally by outside parties such as potential investors, a balance sheet shows how the company was financed and what resources it has. It lets potential investors judge a business’s financial health and use this information when deciding whether to invest.

What does a balance sheet consist of?

A balance sheet has three main parts: assets, liabilities, and shareholders’ equity. Here’s what each one means.

Assets

In simple terms, assets are anything a company owns that can be converted into cash. Assets can be split into two categories: current and fixed.

  • Current assets: what you expect to convert to cash within a year, such as cash, accounts receivable, and inventory.
  • Fixed assets: long-term holdings such as property, equipment, and long-term investments.

Liabilities

Liabilities are the opposite of assets—they are what a company owes others. This includes debts or other financial obligations. Liabilities are current (due within a year) and long-term (due more than a year away).

  • Current liabilities: due within a year, such as accounts payable, employee wages, and taxes owed.
  • Long-term liabilities: due after a year, such as long-term loans and bonds your company has issued.

Shareholders’ equity

Shareholders’ equity is what’s left for owners after liabilities are subtracted from assets. It includes:

  • Stock and share capital: money the company receives from its shareholders.
  • Retained earnings: the net income a company keeps rather than pays out.

The balance sheet equation

The balance sheet equation is: Assets = Liabilities + Shareholders’ equity. Every balance sheet is built on this formula.

This formula is relatively straightforward. That’s because companies have to pay for everything they own (assets) by either borrowing money (liabilities) or by getting money from investors (shareholders’ equity).

Assets should always equal the liabilities and shareholders’ equity. In other words, they should always balance out—hence the name, balance sheet. If they don’t balance out, there is likely incorrect data or a miscalculation.

If a company takes out a $10,000 loan from the bank to cover a store renovation, its assets will increase by $10,000. Its liabilities will also increase by $10,000, balancing out the equation. And if the company takes $5,000 from investors, its assets will also increase by that amount.

What a simple balance sheet looks like

A simple balance sheet lists your assets on one side and your liabilities and shareholders’ equity on the other. Both sides add up to the same total.

Picture a small business on its reporting date. Its assets might include cash, accounts receivable, and equipment. Its liabilities might include a short-term loan and money owed to suppliers. Whatever is left over belongs to the owners.

When you total each side, assets equal liabilities plus equity. That match is how you know your numbers are recorded correctly.

How to create a balance sheet

Follow these five steps to build a balance sheet that shows your business’s financial position on a chosen date.

1. Select the reporting date

A balance sheet shows the total assets, liabilities, and equity of a company on a specific date. That’s why it’s important to determine the exact period you’re reporting on. Most companies prepare their balance sheets each quarter.

2. Identify your assets

After you’ve selected your reporting date, you’ll need to calculate your assets as of that date. It’s best to separate your assets into the two categories we covered—current and fixed. Subtotal both current and fixed assets, then add them together.

3. Identify your liabilities

You’ll also need to record your liabilities. Organize your liabilities into current and long-term. Then, like above, subtotal each category and add them together.

4. Calculate shareholders’ equity

You now need to add the share capital you get from investors and retained earnings.

5. Add and compare

To make sure your equation is balanced, compare total assets against total liabilities plus equity, as seen in the equation above. If your liabilities plus equity equal your assets, you’ve done the equation correctly. If not, you’ll have to go back and rework the formula.

Balance sheet vs. income statement

A balance sheet and an income statement answer different questions about your business. Knowing the difference helps you read each one correctly.

A balance sheet is a snapshot. It shows what you own and owe on a single date. An income statement covers a period of time, such as a month or a year, and shows your revenue, expenses, and profit.

You need both. The income statement shows how your business performed, and the balance sheet shows where it stands.

Keep your business finances in balance

Understanding why balance sheets matter and knowing how to create them is essential to seeing the big picture of your business’s finances. A quarterly or year-end balance sheet helps you check whether you’re on track to meet your goals and gives you a clear overview of your company’s performance.

Keeping your books balanced is easier when payments run on time. Sign up for Melio to automate bill pay and stay in control of your cash flow.

Balance sheet FAQs

What is the main purpose of a balance sheet?

A balance sheet gives you a snapshot of your business’s financial position on a specific date. It shows what you own, what you owe, and what’s left for the owners.

What is the difference between a balance sheet and an income statement?

A balance sheet shows your finances at a single point in time. An income statement shows your revenue, expenses, and profit over a period, such as a month or a year.

How often should a small business prepare a balance sheet?

Many small businesses prepare a balance sheet each quarter. You can also create one monthly or at year-end, depending on your reporting needs.

*This blog post is intended for informational purposes only and is not intended as financial advice.
**Melio does not provide legal, tax or accounting advice, and you should consult with a professional advisor before making any financial decisions.

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