Accounting Advice

How to read the balance sheet

07 Aug 2013

The balance sheet - important to understand or not?

The reality is that at least half of the items on the balance sheet are really only there for accountants, and don't matter much in the real world. However, the other half of the items are vital.

Understanding your business balance sheet is without doubt important. Our ethos is to ensure that we explain to clients technical accounting principles, facts and figures in plain English, practical terms. This way clients gain valuable insights without being bamboozled or overly bored! Get in touch to find out more about us and why we are a good fit for sme clients or get a quote straight away instead.

Balance sheet only matters for the year end accounts right?

Things like tangible assets, goodwill, shareholders funds and net asset value are often only calculated once per year, and typically many months after the year end has closed. If it was important, you'd want to see it at least quarterly and probably monthly. 

But there are a handful of numbers which are really useful when running a small business or analysing company books.

The ones to watch are the items most closely connected to cash (and indeed cash itself), such as :

Working capital

Working capital comprises trade debtors (the amount owed to the company by clients), trade creditors (the amount owed by the company to suppliers) and stock.

I your trade debtor value is going through the roof, all of the hard earned cash that would have been generated by the business, is absorbed because you are effectively financing the operations of your clients.

Equally, if the company bookkeeper suddenly has a burst of activity and pays all of your contractors in one go, the decrease in trade creditors will cause a good deal of cash to be consumed.


Once cash has been properly considered, the other important part of the balance sheet for business owners is the company's debt position and in particular the value and status of any loans provided to the business.

On the balance sheet, a company’s debt is split between current creditors (for debts due within 12 months) and long term creditors. So that means if a company has a £2m loan it is repaying over 5 years, £400k will be in current creditors and the balance will be in long term creditors.

But the problem is that the current creditor figure also includes non-financing debt – things like taxation (i.e. corporation, VAT or PAYE due to HMRC) and trade creditors. So you need to have a good look through the notes to the accounts to separate these out. 

Many healthy companies will run a relatively large current creditor balance, because there is no need to pay HMRC or suppliers before you need to. So here are a couple of quick checks that you can do to see if these components of debt look OK:

  1. Trade creditors: take the number in the accounts and divide it by the sum of expenses excluding property and employees, then multiply by 365. This will give you an idea of the time it is taking the company to pay invoices. If it is around 30 days, then that’s pretty typical.
  2. Taxation creditors: add up the latest corporation tax bill (from the P+L), then calculate the typical outstanding PAYE bill by adding in 45% of the annual employee costs divided by 12. You can also try to make an estimate of the average VAT bill, which can be done roughly by calculating the annual revenue minus the sum of expenses (excluding property and employees) multiplied by 20% divided by 4. If when you add all of this up, it ties broadly to the number in the balance sheet, that’s about what you would expect for a company operating normally.
  3. Bank loans: once you have added up the bank debt in both current and long term debt, you need to compare this to the EBITDA. There was a time when banks would lend 5 – 6x EBITDA, but small business lending in the current climate tends not to exceed 2.25x EBITDA. Any more and it may well be the case that EBITDA is below the level anticipated when the loan was taken out.

As the above suggests, it's one thing making the best use of cost effective accounts software, which is now excellent. However, this alone, without understanding the figures and using data the right way, means you may be missing out on important ways to improve your business and/or reduce risk.

Balance sheet guidance and other helpful accounts and tax

At Accounts & legal we specialise in helping small businesses get the most out of technology whilst also passing on our experience, know how and ideas, all at very competitive prices.

If you haven't had a quote from an accountant recently or are thinking of changing accountants, why not try drop in to see us at our London head office or try our Instant Accounting Quote?


Keir Wright-Whyte


Managing Director

0207 043 4000

About the author

Originally graduating with a degree in geography from Edinburgh University, Keir claims that he was then tricked into becoming an accountant by one of the UK's top 5 accountancy practices.The deception extended to the usual training in audit and associated activities.

Keir subsequently worked in a number of advisory roles with clients including in the energy trading, pharmaceuticals and financial services sectors.

He loves working at Accounts & Legal because of the variety of work and clients, the excellent team ethos and morale, the importance placed on genuinely helping and being useful for clients and because he believes what he does matters to clients and helps the firm.

Keir's primary role is to ensure that new clients with complex businesses or needs are on-boarded in the best way and he is a "trouble shooter" both for clients and where complex issues arise internally. He also helps the accounting teams strive to improve what we do for clients, whether processes or services.

When not debiting or crediting, Keir has a penchant for fixing old buildings, skiing, surfing and cycling.


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