What a Balance Sheet Tells You
The Balance Sheet is a photograph of a business's finances at one specific moment. Unlike the Income Statement, which covers a period of time, the Balance Sheet says: "As of this date, here is what we have, here is what we owe, and here is what belongs to the owner."
The Fundamental Structure
Assets = Liabilities + Equity
The Balance Sheet is always built on this equation. The left side (assets) shows what the business owns. The right side (liabilities + equity) shows how those assets were funded — by borrowing (liabilities) or by the owner's investment and retained profits (equity). The two sides must always be equal. If they're not, there's an error in the books.
Assets: Current vs. Fixed
Assets are divided into two main groups based on how quickly they can be converted to cash:
| Classification | Definition | Examples |
|---|---|---|
| Current Assets | Expected to be used or converted to cash within one year | Cash, Accounts Receivable, Inventory, Prepaid Expenses |
| Fixed Assets (Non-Current) | Long-term assets not easily converted to cash | Equipment, Furniture, Vehicles, Buildings, Accumulated Depreciation |
Assets are listed in order of liquidity — how quickly they can become cash. Cash comes first because it's already cash. Accounts Receivable comes next because customers will pay soon. Inventory follows because it must be sold and then collected. Equipment comes last because it would take time to sell.
Accumulated Depreciation
Fixed assets lose value over time. Accumulated Depreciation is a contra-asset account — it reduces the value of fixed assets on the balance sheet. If equipment cost ₱50,000 and accumulated depreciation is ₱12,000, the net book value is ₱38,000.
Liabilities: Current vs. Long-Term
Liabilities are also divided by timing:
| Classification | Definition | Examples |
|---|---|---|
| Current Liabilities | Due within one year | Accounts Payable, Sales Tax Payable, Short-Term Loans, Accrued Expenses |
| Long-Term Liabilities | Due after one year | Mortgage Payable, Long-Term Loans, Equipment Financing |
Equity Components
Equity represents the owner's stake in the business. For a small business, it typically includes three accounts:
- Owner's Capital: The initial and additional investments the owner has put into the business.
- Retained Earnings: The accumulated profits the business has earned and kept (not distributed to the owner). This account is updated at the end of each accounting period.
- Owner's Draws: Money the owner has taken out of the business for personal use. This is a contra-equity account — it reduces total equity.
Key distinction
Owner's Draws are not an expense. Expenses are costs of running the business and appear on the Income Statement. Draws are the owner taking profits out, and they appear on the Balance Sheet as a reduction to equity.
How to Read a Balance Sheet
When you look at a Balance Sheet, you're checking the financial health of the business. Here's what to look for:
- Liquidity: Can the business pay its short-term bills? Compare current assets to current liabilities. If current assets are at least 1.5–2 times current liabilities, the business is in good shape. This is called the current ratio.
- Debt levels: How much of the business is financed by debt vs. owner's money? If liabilities are more than 50% of total assets, the business may be over-leveraged.
- Equity trend: Is equity growing over time? Compare Balance Sheets from different periods. Growing equity means the business is retaining profits and building value.
- Asset quality: Are the assets mostly cash and receivables, or mostly equipment? A business with lots of fixed assets but little cash may have trouble paying bills even if it looks "big" on paper.
Current Ratio = Current Assets ÷ Current Liabilities
A current ratio below 1.0 means the business cannot pay its short-term obligations with its short-term assets. That's a red flag. A ratio of 2.0 is comfortable. Above 3.0 might mean the business is sitting on too much cash instead of investing it.
Sample Balance Sheet — Sweet Crumbs Bakery
As of December 31, 2025. All figures in Philippine Pesos (₱).
| Account | Amount (₱) |
|---|---|
| ASSETS — Current | |
| Cash — Checking (1010) | 85,000 |
| Cash — Savings (1020) | 40,000 |
| Accounts Receivable (1100) | 15,000 |
| Inventory — Raw Materials (1200) | 22,000 |
| Inventory — Finished Goods (1250) | 8,000 |
| Total Current Assets | 170,000 |
| ASSETS — Fixed | |
| Equipment (1500) | 120,000 |
| Less: Accumulated Depreciation (1510) | (30,000) |
| Total Fixed Assets (Net) | 90,000 |
| TOTAL ASSETS | 260,000 |
| LIABILITIES — Current | |
| Accounts Payable (2000) | 28,000 |
| Sales Tax Payable (2100) | 7,000 |
| Short-Term Loan Payable (2200) | 25,000 |
| Total Current Liabilities | 60,000 |
| LIABILITIES — Long-Term | |
| Long-Term Portion of Loan | 15,000 |
| TOTAL LIABILITIES | 75,000 |
| EQUITY | |
| Owner's Capital (3000) | 150,000 |
| Retained Earnings (3100) | 45,000 |
| Less: Owner's Draws (3200) | (10,000) |
| TOTAL EQUITY | 185,000 |
| TOTAL LIABILITIES + EQUITY | 260,000 |
Check the math
Total Assets = ₱260,000. Total Liabilities + Equity = ₱75,000 + ₱185,000 = ₱260,000. The balance sheet balances. Current ratio = ₱170,000 ÷ ₱60,000 = 2.83 — strong liquidity. The business is healthy.