Balance sheet basics for small businesses: How to read one and what it shows

Published on Tuesday 9 September 2025

Table of contents

• What is a balance sheet?
• Why balance sheets matter for small businesses
• Key components of a balance sheet
• How to read a balance sheet
• Important financial ratios from your balance sheet
• How to create your first balance sheet
• Common balance sheet mistakes to avoid
• How Xero simplifies your balance sheet reporting
• FAQs on balance sheets for small businesses

Key takeaways

• Balance sheets show you what your business owes and owns at a specific point in time.
• A balance sheet helps you analyze your business's financial health.
• A balance sheet helps you use important ratios to reveal in detail how your business is performing.
• Xero automatically creates balance sheets when you enter financial transactions for your business.

What is a balance sheet?

The most basic balance sheet definition is that it's a report of a business's financial health at a single point in time. It shows all of the business's assets, debts, and owner investments (owner equity).

Why balance sheets matter for small businesses

A balance sheet clearly summarizes your business's finances. You can easily see your cash on hand, what clients owe you, and what you owe others. It also shows the value of your assets and how much equity (value) you've got in the business.

These details help you decide when to invest in the business, take out loans, and inform other financial decisions. The balance sheet also has essential info for financial ratios (see below) that show your business’s performance in detail. And lenders often want to see a balance sheet for small business loan applications.

Key components of a balance sheet

The basic balance sheet format is just three sections: assets, liabilities, and owner's equity. But there are details in each of these sections that you need to understand if you want to know how to read a balance sheet.

Assets – what your business owns

Located at the top of the balance sheet, the assets section shows your current and non-current assets. It also shows contra-assets – such as depreciation you’ve claimed against your long-term assets, or "doubtful debts" (bills you don't think your clients are going to pay).

• Current assets include cash, stocks, inventory, and accounts receivable (money your clients owe you) – assets you’re likely to convert into cash in the next year
• Non-current assets are designed to last longer – they include equipment, vehicles, and real estate.
• Most balance sheet formats also show contra assets if applicable – for example the accumulated depreciation as a contra asset.

Here's an example:

Current assets

• Bank account $10,000

Non-current assets

• Vehicle $45,000
• Building $390,000

Contra assets

• Building accumulated depreciation ($50,000)

Total assets $395,000

Liabilities – what your business owes

The liabilities section shows both your current and non-current debts.

• Current debts are those you’ll probably repay in the current year – like sales tax due, payroll taxes, and credit cards.
• Non-current (long-term) debts are paid over several years – like mortgages and business loans.

Here's an example:

Current liabilities

• Credit card $2000
• Payroll tax $10,000
• Sales tax $20,000

Non-current liabilities

• Vehicle loan $40,000
• Mortgage on building $300,000

Total liabilities $372,000

Keep in mind that the current liabilities section doesn't show everything you'll owe over the upcoming year – it just shows what you owe on the date you generate the balance sheet.

Say you run a balance sheet on August 1 – it'll show the sales tax you owe from July's sales, but it won't show the sales tax you owe for the rest of the year.

Equity – what your business is worth

The equity section is assets minus liabilities – basically, what the business is worth (what’s left after you’ve paid off your debts) if you settled up today.

There can be a few different accounts in the equity section depending on how you set up your accounting records.

• Owner's equity or capital – if you have an unincorporated sole proprietorship, partnership, or LLC, this might be the only line in the equity section. But it may be split up into owner investment (money put into the company) and owner draws (money taken out).
• Shareholders' equity – the same as owners' capital but for corporations.
• Retained earnings – the same for incorporated and unincorporated businesses. This includes profits that were not distributed to owners, either as draws (money you take out of an unincorporated business) or dividends (money paid to shareholders of a corporation).

To continue with the above examples, if your business has $395,000 in assets and $372,000 in liabilities, it'll show $24,000 in owner or shareholder equity. Again, that might be a single line – or it could be $20,000 in retained earnings and $4000 in owner's equity, for example.

How to read a balance sheet

Reading a small business balance sheet can be challenging at first, but once you know what to look for, it's pretty straightforward.

Here’s a balance sheet sample to better understand how it works.

• The assets are at the top – you'll see a list of all your business's assets divided into current and non-current subcategories.
• Then, your liabilities – again, grouped into current and non-current categories.
• The bottom section shows your equity (value) in the company.

Important financial ratios from your balance sheet

Here are just some of the insights you can get from the balance sheet.

Liquidity ratios

Liquidity ratios show you if you have enough cash to cover your bills in the short term. There are a few different types:

• Current ratio: current assets / current liabilities
• Quick ratio: (cash + accounts receivables + marketable securities) / current liabilities
• Cash ratio: (cash + marketable securities) / current liabilities

The current ratio shows whether you can cover short-term liabilities if you liquidate all of your current assets (like cash, investments, inventory, accounts receivable, etc). The quick ratio shows you what happens if you don't sell any inventory. What if clients don't pay their invoices? That's where the cash ratio comes into play.

Solvency ratios

Solvency ratios help you compare your profits with your debt. You need the balance sheet and the profit and loss report to calculate these ratios.

The basic solvency ratio is:

Solvency = (net income + depreciation) / total liabilities

The answer shows you how long it will take to pay off all your debts if you use all your profits to repay debt. Say you have $80,000 in net income, $20,000 in depreciation, and $500,000 in short- and long-term liabilities.

1/5 = ($80,000 + $20,000)/$500,000

This means you can pay off a fifth of your debt per year – or if your profits stay the same, all of it over the next 5 years.

Efficiency ratios

Efficiency ratios show how effectively your business uses its assets and manages its finances. The ideal ratio varies by industry and business goals, so it’s worth getting advice from an accountant or business mentor to see if you’re on track.

To calculate efficiency ratios, you’ll need both your balance sheet and your profit and loss statement. Common types of efficiency ratios include:

• Inventory turnover ratio – How quickly do you sell and replace inventory? Formula:Cost of goods sold ÷ Average inventory

• Accounts receivable turnover ratio – How fast do customers pay you? Formula: Net credit sales ÷ Average accounts receivable

• Accounts payable turnover ratio – How quickly do you pay your suppliers? Formula: Net credit purchases ÷ Average accounts payable

• Asset turnover ratio – How much revenue do you generate for each dollar of assets? Formula: Net sales ÷ Average total assets

An accountant or business mentor can help you apply the right efficiency ratios in each case.

How to create your first balance sheet

It’s best to ask your accountant to help you draft a balance sheet.But if you want to take a DIY approach, here are the basics.

Collect all your financial statements

Such as loan documents, bank statements, inventory reports, how much you owe to vendors, and how much clients owe to you.

List your assets

Cash, inventory, and securities go in the current assets section, while most other assets go into the long-term assets section.

Write down your liabilities

The liabilities section notes everything you owe, including credit cards, loans, and sales and payroll taxes. Anything you’re likely to pay within 12 months goes into the short-term section, while the rest go into the long-term section.

Calculate owner equity

Take your total assets and subtract the total liabilities.

You don’t have to do this yourself. Xero, for example, creates a balance sheet in the background as you enter your revenue, expenses, loan payments, invoices, and other details.

Common balance sheet mistakes to avoid

Avoiding these common balance sheet errors can help keep your financial reports accurate and useful:

• Misclassifying accounts – When adding new accounts to your chart of accounts, be sure to classify them correctly as assets, liabilities, equity, expenses, or income.
• Underestimating its importance – A balance sheet is a key tool for assessing your business’s financial health and spotting errors in your accounting records.
• Not working with a professional – An accountant or experienced bookkeeper can help you interpret your balance sheet and uncover valuable insights about your business’s performance.

How Xero simplifies your balance sheet reporting

Xero automates the whole process. As you enter financial details and transactions, it automatically creates a balance sheet that's perfect for loan applications, tax prep, bringing in investors, or figuring out your next business move. It's also required for tax prep if you run a corporation or elect to be taxed as an S-corp.

Ready to simplify your balance sheet reporting? Get one month free.

FAQs on balance sheets for small businesses

Balance sheets are complicated, and the questions are never-ending – here are answers to some of the most frequently asked.

How often should I update my balance sheet?

Ask your accountant to check and update it at least once a year. Accounting software like Xero updates your balance sheet automatically whenever you enter transactions.

For example, when you borrow money or buy a new asset, you'll create a liability or asset account in your chart of accounts – which creates an instant update to your balance sheet.

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

The balance sheet shows assets and liabilities at a fixed point in time. The profit and loss report (your income statement) shows income and expenses over a period of time.

To create a balance sheet, you pick a date; for an income statement, you choose a period.

Do I need an accountant to create a balance sheet?

No, you don't. Your accounting software will do it for you. But an accountant can help you set everything up and check on your records every so often.

How can I improve the numbers on my balance sheet?

Use your balance sheet to calculate liquidity, solvency ratios, and efficiency ratios. Then, let those numbers guide you in the right direction.

How do I show stocks on a balance sheet?

When you buy a stock, create an account for that stock in your chart of accounts – you can lump all the stocks together or create an account for each stock you buy. Then, if you buy the stocks out of your business bank account, select the stock as the account when you classify that expense transaction.

How do I find retained earnings on a balance sheet?

Retained earnings are in the equity section of the balance sheet. If you don't see an entry, that means you withdrew all the profits from your business.

Which accounts don’t appear on the balance sheet?

Your balance sheet does not show income, profit, or expenses – that's all on the profit and loss report.