Encyclopedia of terms for small business owners

A balance sheet is a financial statement that shows what your business owns, what it owes, and what it's worth at a specific point in time, usually the last day of your financial year. It's called a balance sheet because the two sides of it must always balance: everything the business owns (its assets) must be funded by either money it has borrowed (liabilities) or money that was invested or earned and kept in the business (equity). The fundamental accounting equation: Assets Liabilities + Equity Or put another way: what you own what you owe + what's yours For UK limited companies, a balance sheet is a legal requirement and must be filed annually with Companies House as part of your statutory accounts. Sole traders and partnerships don't have a legal obligation to prepare one, but it's a valuable tool for understanding your financial position. What's on a Balance Sheet? Assets Assets are split into two categories: Non-current (fixed) assets, things you own for the long term: property, vehicles, equipment, computers, and intangible assets like trademarks or goodwill Current assets, things that will be converted to cash within 12 months: cash in the bank, money owed to you by customers (debtors), and stock or inventory Liabilities Liabilities are also split into two categories: Current liabilities, debts due within 12 months: supplier invoices you haven't paid, VAT due, PAYE due, short-term loans Non-current (long-term) liabilities, debts not due for more than 12 months: bank loans, mortgages on business property, hire purchase agreements Equity Equity (also called net assets, shareholders' funds, or capital and reserves) is what's left when you subtract all liabilities from all assets. For a sole trader, this is called 'capital'. For a limited company, it includes share capital and retained profits. 📊 Example A simplified balance sheet for a small UK limited company: ASSETS Fixed assets (van, equipment): £18,500 Debtors (invoices outstanding): £9,200 Cash in bank: £6,400 Total Assets: £34,100 LIABILITIES Supplier invoices due: £4,300 VAT due: £2,100 Bank loan (long-term): £8,000 Total Liabilities: £14,400 EQUITY Share capital + retained profits: £19,700 Check: £14,400 + £19,700 £34,100 ✓ Balance Sheet vs P&L: What's the Difference? The profit and loss account shows performance over time, what happened during the year. The balance sheet shows position at a point in time, what the business is worth right now. A useful analogy: the P&L is like your bank statement (it shows transactions over a period), while the balance sheet is like a snapshot of your bank account balance, assets, and debts all at once. What Does a Balance Sheet Tell You? Lenders, investors, and buyers all scrutinise the balance sheet because it reveals: Financial stability, does the business have more assets than liabilities? Liquidity, can it pay its short-term debts? (see working capital) Leverage, how much debt is being used to fund the business? Net worth, what would be left if everything was sold and all debts repaid? Frequently Asked Questions Does a sole trader need to prepare a balance sheet? There is no legal requirement for sole traders to prepare a formal balance sheet, but it is good practice, particularly if you're applying for a business loan, as lenders will want to understand your financial position. What does it mean if a balance sheet is 'out of balance'? If your assets don't equal your liabilities plus equity, there's an error somewhere, a missing entry, a duplicate transaction, or a calculation mistake. In a properly maintained set of accounts, the balance sheet must always balance. What is negative equity on a balance sheet? Negative equity means your total liabilities exceed your total assets. For a limited company, this can be a serious warning sign and may indicate insolvency risk, though it's not automatically the case for all business types.

What is a Balance Sheet?

What is a Profit and Loss Account (P&L)?

What is a Profit Margin?

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What is Working Capital?