Financial Reports23 October 20266 min read

How to Read a Balance Sheet: The Five Lines That Actually Matter

A balance sheet runs to dozens of lines, and five tell you almost everything. Which five, what order to read them in, and the one sum worth doing.

It answers a question your P&L cannot

Your profit and loss account covers a stretch of time: what came in and what went out over a month, a quarter, a year. A balance sheet covers a moment, the position of the business on one named day, usually a month end or your year end.

That difference is the whole point. The P&L tells you whether the trading is any good. The balance sheet tells you whether you can survive the next few months. Both matter, and only one of them usually gets read.

A full balance sheet out of Xero, QuickBooks or Sage runs to dozens of lines. Five of them tell you almost everything, and they are best read in this order.

1. Cash at bank

Start here, because it is the only line on the report that is simply a fact. Nearly everything else involves somebody's judgement: what stock is worth, how fast a van loses value, whether a customer will ever pay. Cash is just cash.

Then stop looking at it, because on its own it tells you nothing about whether you are all right. A business with £80,000 in the bank and £120,000 falling due next month is not all right.

2. Money your customers owe you

Usually labelled trade debtors, or just debtors, sometimes accounts receivable: work you have invoiced and not been paid for.

The number matters less than the question you should ask of it: how long has it been sitting there? Debtors all under a month old are near enough cash. A balance with a six month old invoice inside it is not an asset in any useful sense, and the balance sheet will not tell you which of the two you have. Your accounting software will age the list for you, and debtor days turns it into one figure you can watch month to month.

3. What you owe within the next twelve months

On a UK statutory balance sheet this is headed "Creditors: amounts falling due within one year", and the twelve month part is what makes it the most useful heading on the document. It holds unpaid supplier invoices, the VAT you have collected and not yet handed over, PAYE, corporation tax, and the next year of any loan.

The tax lines are the ones owners miss. VAT you charged a customer was never your money: it sits here because it is owed, and the fact that it is in your bank account today is a timing accident rather than a cushion.

4. Net current assets, and the one sum worth doing

Now do the single piece of arithmetic that earns its keep. Take everything due to turn into money within a year, subtract everything due to leave within a year, and you have working capital. Your accounts may print it for you as net current assets.

The figures below are invented to show the shape, not taken from any real business. Say a small contractor's balance sheet reads:

Cash at bank: £62,000
Trade debtors: £94,000
Materials in stock: £12,000
Creditors falling due within one year: £129,000, being £71,000 of supplier invoices, £23,000 of VAT, £9,000 of PAYE, £14,000 of corporation tax and £12,000 as the next year of a loan

Current assets come to £168,000, so net current assets are £39,000. That is the real headroom, and a very different impression from the £62,000 of cash you started with. Note also that £94,000 of the £168,000 depends on other people choosing to pay: working capital is a promise about the next twelve months, not a fact about today.

If the figure is negative, the business owes more within the year than it expects to receive within it. Not automatically fatal, plenty of businesses trade through it, but it is the clearest single warning a balance sheet gives you and better to know before your bank points it out.

5. Net assets, and its direction

The bottom line is net assets, also called equity or capital and reserves: everything the business owns less everything it owes, or what would be left for the owner after selling up and settling the debts.

The number on its own is almost useless. The direction is what matters. Put this year's net assets next to last year's and you have measured what the business actually added.

Carrying on the illustration: say net assets are £57,000 now and were £44,000 a year ago, so the business added £13,000 of value. If the P&L for that same year showed £60,000 of profit, and assuming no new money was put in, then roughly £47,000 left again as dividends or drawings. Neither figure is wrong and neither is visible on its own.

What to do with it

Once a month, write down five numbers: cash, debtors, creditors due within the year, net current assets, and net assets. After three months you have a trend, and a trend in those five tells you more than any single month's full report.

Two things to watch for. Debtors rising faster than sales means your customers are paying more slowly, whatever the sales line says. Net current assets falling while profit holds up is the same thing arriving a step later.

How CFO Pal reports yours

Your balance sheet comes through from Xero, QuickBooks or Sage, is reported in the management accounts pack, and you can ask the chat for it directly. Nothing in it is estimated: working capital needs every section of your accounts to be identifiable as falling due within a year or after it, so where that cannot be established the pack says so rather than printing an approximation. The arithmetic is checked against your platform's own printed section totals rather than only against itself, and where a section carries a sign that is unusual for its side of the sheet it is reported exactly as it stands, flagged as something a reader will ask about, rather than quietly tidied up.