TL;DR
Your balance sheet tells you what your business owns, what it owes, and what's left over for you. Here's how to read it without an accounting degree.
Most business owners look at their P&L every month. Revenue up, expenses down, profit good. But if you're not looking at your balance sheet, you're only seeing half the picture.
I had a client last year who was showing $80K in profit on the P&L but couldn't figure out why their bank account was shrinking. The answer was on the balance sheet: their accounts receivable had ballooned to $220K because customers were paying slower and slower. Profitable on paper. Cash-poor in reality.
The Basic Equation
Assets = Liabilities + Equity. That's it. Everything your business owns (assets) was paid for either with borrowed money (liabilities) or money from the owners (equity). This equation always balances. If it doesn't, something is wrong in your books.
Assets: What You Own
Assets are split into two categories: current and long-term.
Current assets are things that will convert to cash within a year. Your bank accounts, accounts receivable (money customers owe you), inventory, and prepaid expenses. These are your liquidity. They're what you use to pay bills next month.
Long-term assets are things you'll hold for more than a year. Equipment, vehicles, real estate, leasehold improvements. These get depreciated over time, so their book value drops each year.
Here's what I tell my clients: pay attention to your current assets first. If your bank balance is $30K but your AR is $180K, the question isn't "how much do I have?" It's "when is that $180K actually going to show up?"
Liabilities: What You Owe
Same split: current and long-term.
Current liabilities are debts due within a year. Accounts payable (bills you haven't paid yet), credit card balances, the current portion of any loans, HST/GST owing, payroll liabilities (source deductions you've withheld but haven't remitted to CRA yet), and accrued expenses.
Long-term liabilities are debts due beyond a year. Term loans, mortgages, shareholder loans (if structured as long-term). These are less urgent but still reduce what the business is worth.
The CRA liabilities are the ones that catch people. If you've been collecting HST and withholding payroll taxes, that money is not yours. It's sitting in your bank account looking like cash, but it belongs to CRA. I've seen businesses spend it accidentally and then get hit with a $40K remittance they can't cover.
Equity: What's Left for You
Equity is the residual. Total assets minus total liabilities. It includes the money originally invested in the business (share capital), retained earnings (accumulated profits that haven't been paid out), and current year earnings.
If equity is negative, your business owes more than it owns. That doesn't necessarily mean you're bankrupt, but it means there's no cushion. One bad quarter and you're in trouble.
The Ratios That Matter
You don't need to calculate 20 ratios. Three will tell you most of what you need to know.
Current ratio = Current assets / Current liabilities. Above 1.5 is healthy. Below 1.0 means you might not be able to pay your short-term bills. If you're at 0.8, that's a problem you need to address now, not next quarter.
Debt-to-equity = Total liabilities / Total equity. Tells you how leveraged you are. Above 3.0 and most lenders will start getting nervous. Below 1.0 is conservative.
Working capital = Current assets - Current liabilities. This is the dollar amount you have available to operate. If it's shrinking month over month, something is off even if profits look fine.
Common Problems I See
AR growing faster than revenue. Revenue is up 10% but AR is up 40%. That means you're selling more but collecting slower. Find out why. Is it one big customer dragging their feet? Tighten your terms.
Negative equity from shareholder draws. The owner is pulling out more than the business earns. This erodes the balance sheet over time and makes it nearly impossible to get financing.
Mystery balances in old accounts. A $12K balance in a clearing account that nobody can explain. An asset that was written off two years ago but still on the books. These are signs your bookkeeping needs attention.
What to Do This Week
- Pull your balance sheet from QuickBooks. Run it as of today and compare it to the same date last year.
- Calculate your current ratio. If it's below 1.5, figure out what's dragging it down.
- Look at your AR. What's the total? What's over 60 days? That over-60 number is what keeps me up at night for my clients.
- Check your CRA liabilities. Make sure HST owing and payroll source deductions match what you've actually collected. If they don't, fix it before CRA notices.
- Review equity. Is it growing year over year? If not, where is the money going?
The Bottom Line
Your P&L tells you if you're making money. Your balance sheet tells you if you'll still be in business next year. Read both, every month. If your balance sheet is confusing or you're not sure what the numbers mean, book a free call and I'll walk you through it.
Next step: run your numbers through the free CFO scorecard.
Frequently Asked Questions
- What are the three sections of a balance sheet?
- Assets (what you own), liabilities (what you owe), and equity (what's left for the owners). Assets always equal liabilities plus equity.
- How often should I review my balance sheet?
- Monthly at minimum. Review it alongside your P&L to get the full picture. A profitable P&L with a deteriorating balance sheet is a warning sign.
- What is the most important ratio on a balance sheet?
- The current ratio (current assets divided by current liabilities) tells you whether you can pay your short-term bills. Below 1.0 means you may have trouble. Between 1.5 and 2.0 is healthy for most businesses.
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