While the profit and loss statement covers a period, the balance sheet is a snapshot on a single date. It lists what the business owns, what it owes and what is left for the owners. Many small business owners skip it, but it is where bookkeeping errors usually show up first.

The basic equation

A balance sheet always balances: assets = liabilities + equity. If something is wrong in your books, it often appears as a balance on the balance sheet that does not make sense, such as a negative bank account or a loan that never goes down.

Assets

  • Cash and bank accounts. These should agree with your bank statements on the balance sheet date after reconciliation.
  • Accounts receivable. Invoices customers have not yet paid. Compare with your ageing report.
  • Inventory. Goods held for sale. The IRS covers inventory in Publication 334.
  • Prepaid expenses. Costs paid in advance, such as annual insurance.
  • Fixed assets. Equipment, vehicles and furniture, usually shown at cost less accumulated depreciation. Publication 946 explains depreciation.

Liabilities

  • Accounts payable. Supplier bills not yet paid.
  • Credit cards. Should agree with card statements.
  • Sales tax payable. Tax collected and not yet remitted.
  • Payroll liabilities. Withheld taxes and deductions waiting to be paid.
  • Loans. Principal outstanding, which should agree with lender statements.

Equity

Equity includes money the owners have put in, money they have taken out (draws or distributions) and retained earnings, the accumulated profits of earlier years. Current-year profit or loss also flows into equity.

Balances to check every month

  1. Every bank and card account reconciled to its statement
  2. Receivables that agree with the customer ageing report, with old items followed up or written off
  3. Sales tax and payroll liabilities that match what is due on the next returns
  4. Loan balances that agree with lender statements
  5. No unexplained balances in clearing, suspense or "opening balance" accounts

Warning signs

  • A bank account with a negative balance when the real account is in credit
  • Payroll liabilities that keep growing, which may mean payments are recorded as expenses
  • Fixed assets that never change, which can mean purchases were expensed or depreciation is missing
  • Owner draws that are larger than profit for several years

Key terms

  • Current assets: cash and items expected to become cash within a year, such as receivables and inventory.
  • Current liabilities: amounts due within a year, such as supplier bills, credit cards and payroll taxes.
  • Long-term liabilities: loans or other obligations due after more than a year.
  • Net book value: the cost of an asset less accumulated depreciation.
  • Working capital: current assets minus current liabilities, a quick indicator of short-term financial health.
  • Suspense account: a temporary holding account for transactions that have not yet been identified. It should be cleared regularly.

Why it matters

Lenders read the balance sheet closely, and it tells you whether the business can meet its obligations. The IRS also expects you to keep records that support your assets and liabilities; see its guidance on what records to keep.

Our bookkeeping services include a monthly balance sheet review, and our guide to monthly bank reconciliation explains the first step.