How to read a balance sheet — and what it tells you about your business

Assets are the things and resources the business owns or controls that have current or future value and can be measured in money.

For most businesses that includes:

• cash and bank accounts
• accounts receivable (trade debtors — money customers owe you)
• stock and inventory
• equipment and vehicles
• property
• investments
• supplier deposits and bonds
• prepayments
• intangible assets such as intellectual property, where relevant

On most balance sheets, assets are split into current assets — expected to turn into cash or be used within about a year — and non-current assets, which the business expects to hold for longer. The distinction matters less than the next question.

The total value of assets on its own is not enough.

Two businesses can show the same total assets and be in completely different positions — one holding mostly cash and collectable debtors, the other holding slow-moving stock and equipment that would be hard to sell quickly.

The useful question is not just how much. It is what the assets are made up of, and how readily they could be turned into cash if the business needed it.

Many owners check the bank balance and treat it as the scoreboard. It isn't. Cash is only one line on the balance sheet — and it rarely tells the whole story on its own.

A business can make a solid profit and still have less cash than the owner expects. That is because profit gets used in places that never appear on the profit and loss:

• buying equipment
• repaying loan principal
• buying stock
• funding growing debtors
• owner drawings
• distributions
• paying historical tax liabilities
• other investments

The balance sheet is often part of the answer. It shows where the profit went — what the business has accumulated, and what it has committed to. It is also why profit and cash need to be thought about together, starting with how much the business needs to sell each month just to cover its costs.

If you have ever asked that question, the answer is usually sitting on the balance sheet.

The profit is real. But some of it is now equipment. Some of it went to the ATO for last year's tax. Some of it is sitting in invoices your customers haven't paid yet. Some of it paid down a loan.

None of those uses appear on the profit and loss. All of them appear on the balance sheet.

Accounts receivable — or trade debtors — is the money customers owe the business for invoices already raised.

Say debtors moved from $250,000 to $500,000 over a year. The business is effectively funding its customers for longer. That is not automatically bad — growing revenue may explain it. But it is worth understanding whether the balance is growing, why, and how long customers are actually taking to pay.

Because money tied up in debtors cannot simultaneously fund hiring, pay the tax bill, buy equipment, reduce debt or make a distribution to you.

If that balance keeps creeping up, it is usually a collections question before it is anything else — and there are practical ways to get paid sooner.

Liabilities are the amounts the business owes — to suppliers, staff, the ATO, lenders and others.

Common examples include:

• supplier accounts (trade creditors)
• payroll liabilities
• superannuation payable
• tax liabilities
• business loans
• customer deposits
• interest owing
• other amounts owing

Like assets, liabilities are usually split into current — due within about a year — and non-current. The technical definitions matter less than the owner question underneath them.

That is the more useful way to read the liabilities section.

Some of the money in the bank account is already spoken for — it belongs to the ATO, to suppliers, to staff super. The balance sheet is where that reality lives, even when the bank balance feels comfortable.

Say the business has $250,000 in the bank. It also has a $180,000 ATO liability sitting on the balance sheet.

The bank balance is not the same as available cash.

That doesn't necessarily mean trouble. But $70,000 is not $250,000 — and the difference matters when you're deciding whether to hire, invest or take money out of the business.

This is why tax planning and cash-flow planning need to talk to each other — and why we treat tax as something to understand early, not something to discover after the decisions have already been made.

Most owners think about loans in terms of the monthly repayment. A $4,000 monthly repayment can look manageable in isolation.

The balance sheet shows something the repayment doesn't: the total debt still outstanding. That total is worth considering alongside the tax liabilities and the other commitments sitting around it — because together they describe what the business has already committed to, before anything new is added.

Equity is what remains after liabilities are deducted from assets:

Equity = Assets − Liabilities

Depending on the structure of the business, equity commonly includes contributed capital — money the owners put in — and retained earnings, which are the profits the business has kept rather than distributed. Owner drawings and loan accounts can also move through equity accounts.

It is, in simple terms, the accumulated net position of the owners in the business.

The equity figure on a balance sheet is an accounting number. It is not a market value.

Assets are recorded based on transaction value, which may be very different from what they would sell for today. And what a business is actually worth depends on things the balance sheet doesn't capture — future earnings, recurring revenue, customers, systems, employees, intellectual property, brand and business risk.

The balance sheet alone cannot tell you what the business would sell for. It can tell you what has been accumulated and committed to — which is a different, and still very useful, answer.

Because every transaction affects at least two parts of it.

Say the business buys a vehicle for $50,000, pays a $10,000 deposit from cash, and finances the remaining $40,000.

Vehicle assets increase by $50,000. Cash decreases by $10,000. Liabilities increase by $40,000. Both sides still equal.

The accounting can balance perfectly and the business decision can still need to be assessed separately. Was buying the vehicle a good decision? That depends on the cash position, the cost of the finance, the tax treatment, the productivity it supports, the revenue it's expected to help generate, and what else the money could have been used for.

The balance sheet records what happened. Judgement is still required.

One balance sheet is a snapshot. The movement between two balance sheets is the story.

Consider a business comparing this year with last year:

You don't need to review every account every month. But the following questions are worth asking regularly:

• Is cash increasing or reducing?
• Are customers taking longer to pay?
• Are supplier balances building up?
• Are tax and super liabilities current?
• Is debt increasing?
• Are owner loan accounts moving?
• Is stock tying up more cash?
• Does the balance sheet reconcile with what is actually happening in the business?

A number moving is information. Understanding why it moved is what makes the information useful.

The balance sheet vs profit and loss question comes up often, but it isn't a competition. Each report answers a different question:

• Profit and loss — shows financial performance over a period.
• Balance sheet — shows the financial position at a particular date.
• Cash-flow information — helps explain how cash moved between those positions.

You need all three. A business can report an increased profit while debtors increase by the same amount or more — in which case the additional profit may not yet be additional cash. The profit and loss tells you one thing happened. The balance sheet tells you what it did to the position.

This is the point of reading it at all.

Before hiring another person — consider cash and working capital. Before buying equipment — consider existing debt and upcoming tax. Before making a large distribution — consider what the business already owes. Before borrowing — consider the overall strength of the financial position. Before expanding — consider how much working capital the current business already requires.

The balance sheet forces us to look at what the business has accumulated and committed to, not just what it earned.

This is the kind of reading we do alongside owners in our strategy and advisory work — not as a compliance exercise, but as the ground the next decision stands on.

1. What has changed since the last period?

2. Why did it change?

3. Does that change affect anything we're planning to do next?

The simplicity is the point. If those three questions get asked every time the numbers are reviewed, the balance sheet stops being an accounting document and starts being a decision-making tool.

Owners need to understand cash, debt, tax, debtors, suppliers, owner loans, stock and equity — because those are the things the next decision will touch.

Your balance sheet brings those pieces together.

If you are a Wakefield Pacific client and you are looking at your balance sheet without really knowing what it is telling you, bring it into the next conversation.

We can work through what has changed, what deserves attention and what it means for the decisions you're making.