The Balance Sheet: How to Build It and How to Read It | Free Bookkeeping & Accounting Course

What you'll learn

How a classified balance sheet is organized.
How to build Brightside's balance sheet and connect it to the income statement.
How owner's equity looks for a sole proprietor, an LLC and a corporation.
How to read a balance sheet in five minutes, like a banker.
How to calculate working capital and the cash conversion cycle.

📥 Practice this lesson

The balance sheet in the template pulls every balance from the journal and checks that assets equal liabilities plus equity.

bookkeeping-template.xlsx · Financial Statements sheet

If the income statement is a movie (what happened over a period), the balance sheet is a photograph: what the business owns, what it owes and what belongs to the owners on one specific date. GAAP also calls it the statement of financial position. It's the statement a bank studies first before lending you money, and it's the one most small business owners never look at.

How a balance sheet is organized

The balance sheet is the accounting equation in report form. It's presented side by side or, more often in the U.S., one section above the other:

ASSETS                         |  LIABILITIES
  Current assets               |    Current liabilities
  Long-term assets             |    Long-term liabilities
                               |  OWNER'S EQUITY
                               |    Contributed capital
                               |    Retained profits (less draws)
-------------------------------+-------------------------------
TOTAL ASSETS                   =  TOTAL LIABILITIES + EQUITY

A classified balance sheet splits assets and liabilities into current and long-term. Within each group, U.S. companies list items in order of liquidity: cash first, then receivables, then inventory, then prepaid expenses; for liabilities, the ones due soonest come first.

1. What does the balance sheet show?

Revenue and expenses for a period
Assets, liabilities and equity on a specific date
Cash coming in and going out during a period

The balance sheet is a snapshot on one date ("as of March 31"); the income statement covers a period ("for the month ended March 31").

Brightside's balance sheet

Using the trial balance from lesson 5 and the $2,300 net income from lesson 8. Assume half of the $10,000 bank loan's principal is due within the next 12 months:

Brightside Coffee LLC · Balance sheet as of month-end
Current assets
Cash	$45,500
Inventory	$1,000
Total current assets	$46,500
Long-term assets
Equipment	$12,000
(−) Accumulated depreciation	($200)
Equipment, net	$11,800
TOTAL ASSETS	$58,300
Current liabilities
Accounts payable	$6,000
Current portion of bank loan	$5,000
Total current liabilities	$11,000
Long-term liabilities
Bank loan, net of current portion	$5,000
Total liabilities	$16,000
Member's equity
Maya Torres, capital contributed	$40,000
Net income for the month	$2,300
(−) Draws	$0
Total member's equity	$42,300
TOTAL LIABILITIES + EQUITY	$58,300

It balances. And notice the link between the statements: the $2,300 of profit on the income statement shows up inside equity on the balance sheet. That's how the movie connects to the photograph. Each period's profit, minus what the owners take out, is what makes equity grow.

Here's what Brightside's $58,300 of assets consist of, and who financed them:

Assets: cash $45,500 (78.0%), inventory $1,000 (1.7%) and equipment, net $11,800 (20.2%).

Financing: liabilities $16,000 (27.4%) and member's equity $42,300 (72.6%).

Equity looks different depending on the entity

Business type	Equity section is called	Typical accounts
Sole proprietorship	Owner's equity	Owner's capital, owner's draws
LLC or partnership	Members' or partners' equity	A capital account for each member, plus distributions
Corporation (C or S)	Stockholders' (shareholders') equity	Common stock, additional paid-in capital, retained earnings, minus dividends or distributions

Book value isn't market value

The espresso machine shows up at $11,800 (cost minus depreciation), even if it would sell for $8,000 or $14,000 today. The balance sheet mostly records historical costs, not selling prices, and it leaves out things like a loyal customer base or a great location. That's why a company's equity on paper almost never equals what a buyer would pay for it, a topic you'll come back to in lesson 16.

How to read a balance sheet in five minutes

These are the questions a banker or investor asks:

Can it pay what's due soon?

Compare current assets with current liabilities. Brightside has $46,500 against $11,000: very comfortable.

How much is borrowed?

Compare total liabilities with total assets. Brightside finances 27% of its assets with debt and 73% with Maya's money.

Where is the money parked?

Idle cash earns little; piles of inventory may hide stock that won't sell; growing receivables may hide customers who don't pay.

Is equity growing?

Compare with last period. Equity that shrinks year after year means losses or owners taking out more than the business earns.

Anything odd?

Receivables rising much faster than sales, loans to owners, inventory doubling while sales stay flat.

Balance sheet mistakes small businesses make

When a CPA cleans up a small company's books, the balance sheet is usually where the problems hide. The P&L can look reasonable while the balance sheet quietly drifts away from reality. Watch for these:

Recording credit card payments as expenses and never setting up the card as a liability.

Create a Credit Card Payable account, record each purchase when it happens and reconcile it to the statement monthly.

Showing the whole bank loan as long-term.

Move the principal due in the next 12 months to current liabilities, or your current ratio looks better than it is.

Leaving sales tax collected inside revenue.

Track it in Sales Tax Payable so the balance matches what you owe the state.

Never reconciling payroll liabilities, loans or inventory.

Every balance sheet account should tie to something outside your books: a statement, a payroll report or a count.

Working capital

You'll hear this term constantly:

Working capital = Current assets − Current liabilities
                = $46,500 − $11,000 = $35,500

It's the cushion the business runs on day to day. When it's negative, the company depends on collecting fast or borrowing to pay its short-term bills. Some big retailers run with negative working capital on purpose (customers pay at the register while suppliers are paid in 30 to 60 days), but for a small business it's usually a warning sign.

2. A company has current assets of $80,000 and current liabilities of $50,000. What is its working capital?

1.6
$130,000
$30,000

Working capital = $80,000 − $50,000 = $30,000. The 1.6 is the current ratio ($80,000 ÷ $50,000), which you'll use in the next lesson.

The cash conversion cycle

The balance sheet also shows how long your money is tied up before it comes back as cash:

Days in inventoryGoods wait on the shelfHow long, on average, inventory sits before it's sold.
Days in receivablesCustomers take time to payHow long it takes to collect after a sale on credit.
Minus days in payablesYou take time to pay suppliersSupplier credit finances part of the cycle for you.
ResultDays your cash is locked upThe shorter, the less financing you need.

Cash conversion cycle = Days in inventory + Days in receivables − Days in payables

If goods sit 30 days, customers pay in 45 and you pay suppliers in 30, your cash is tied up for 45 days. The faster you grow, the more working capital you need. Shortening the cycle, by collecting sooner, buying closer to when you sell or negotiating longer supplier terms, frees cash without a loan. A coffee shop like Brightside has a short cycle: customers pay on the spot and beans sell within days.

The growth trap

A business that sells on credit and grows fast can run out of cash precisely because it's growing: it pays for more inventory and payroll today, but collects weeks later. If you plan to grow, forecast your cash, not just your sales (lesson 11 shows how).

3. Days in inventory: 40. Days in receivables: 30. Days in payables: 25. What is the cash conversion cycle?

95 days
45 days
35 days

40 + 30 − 25 = 45 days between paying suppliers and collecting from customers.

4. Brightside's net income for the month was $2,300 and Maya took no draws. By how much did equity grow?

$2,300
$42,300
$0, because equity only changes when the owner invests

Net income flows into equity. With no draws, equity rose from the $40,000 invested to $42,300.

Practice exercise

An appliance retailer in Phoenix, organized as an S corporation, has these balances: Cash $30,000; Accounts receivable $80,000; Inventory $120,000; Equipment $150,000; Accumulated depreciation $50,000; Accounts payable $90,000; Short-term loan $40,000; Long-term loan $60,000; Common stock $100,000. Retained earnings are missing.

Build the balance sheet and find retained earnings so that it balances.
Calculate working capital.
What percentage of assets is financed with debt?

See solution

Current assets:    $30,000 + $80,000 + $120,000 = $230,000
Long-term assets:  $150,000 − $50,000          = $100,000
Total assets                                    = $330,000

Current liabilities: $90,000 + $40,000         = $130,000
Long-term liabilities                           =  $60,000
Total liabilities                               = $190,000

Stockholders' equity = $330,000 − $190,000      = $140,000
Retained earnings    = $140,000 − $100,000      =  $40,000

Working capital = $230,000 − $130,000           = $100,000
Debt ratio      = $190,000 ÷ $330,000           =    57.6%

Note: more than half of current assets is inventory ($120,000). If it sells slowly, real liquidity is lower than working capital suggests. The quick ratio in the next lesson measures exactly that.

Summary

The balance sheet shows assets, liabilities and equity on a single date, and always balances.
A classified balance sheet separates current and long-term items, listed in order of liquidity.
Net income minus draws or dividends flows into equity, linking the income statement to the balance sheet.
Working capital = current assets − current liabilities.
Assets are mostly carried at historical cost, not market value.

Next lesson: The Cash Flow Statement and Financial Ratios. You'll see why Brightside's cash grew far more than its profit and diagnose a business with a handful of ratios.