What Is a Balance Sheet? A Simple Explanation for Entrepreneurs

The Balance sheet is one of the most basic business reports, which any entrepreneur needs when submitting a tax return. But it is so much more than that. In this article, I will lay it out in everyday terms.

🌟 Do you know the book value of your company?

This is the basic question that the Balance sheet answers. It summarizes everything your company owns, and everything it owes – at a specific moment in time.

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Why is it called Balance?

The core principle of the Balance sheet is, that it shows the total value of your company from two angles, which are always equal to each other:

• Assets – where your money is.
• and the Liabilities and Equity – where the money is coming from.

In Dutch accounting, the Balance Sheet is traditionally divided into Activa and Passiva, terms that come from Latin and pre-date the English definitions. The Activa side contains everything the business owns. The Passiva side shows where the money came from: the owners (equity) and third parties such as banks and suppliers (liabilities). For this article, I’ll stick with the English definitions: Assets, Liabilities and Equity.

I’ve always found the treatment of Equity interesting. In Dutch accounting, it sits on the Passiva side because it represents value that ultimately belongs to the owners. Yet unlike a bank loan, the capital invested in a business often remains there indefinitely, even if the founders sell their shares and new owners take their place. Profits may be distributed as dividends, but the underlying capital usually stays invested for as long as the company exists. That’s why English accounting typically distinguishes between Equity and Liabilities.

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Let’s start with the Assets

Assets can be further split into

• Invested or Long term assets (Vaste activa) – these serve your company for longer than a year. Like a laptop of a coach, the camera of the photographer, but also financial assets that are invested for longer than a year fall under invested assets. For example, if your company is an owner of another company, and plans to hold onto that business longer than a year.
• Current assets (Vlottende activa)
• Liquid financial assets – such as cash, bank balances and short term saving accounts (for example a VAT saving account)
• Debtors – money that is owed to the company for example, by clients.
• Inventories and Materials – things that the company uses in its everyday operation.

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And the other side of the equation: Liabilities and Equity

• Liabilities are similarly split between long-term (beyond the financial year) and short-term:- - Short term liabilities – for example the VAT within the current quarter, or Accounts payable (Creditors).
  • Long-term liabilities, such as loans and mortgages
  • Equity is what the company ‘owes’ to its owners or shareholders. It represents the value that belongs to the owners after all liabilities have been deducted.
  • Within the Equity sits one very important element, the Result.

💰 The RESULT is the balancing element of the ⚖️ Balance sheet – it can be both positive or negative.

The Result (profit or loss) is the portion of Equity that changes as your business operates.

• • • If your company earns more than it spends, it generates a profit 🎉 and Equity increases.
  • If your company spends more than it earns, it creates a loss 💥 and Equity decreases.

Think about it this way: if your business is profitable, some of that profit will usually show up somewhere on the Asset side. Perhaps your bank balance increases, you own more inventory, or customers owe you more money. If your business makes a loss, the opposite happens and Equity decreases.

⚖️ The TOTAL of the Assets = Liabilities + Equity (including the Result). That’s the rule of the Balance sheet – hence the name.

📆 Note, that the Balance sheet is always a snapshot at a fixed moment in time of the status of the company. You start with an opening balance – most likely your starting equity paid into the business bank account – but every day, as you are doing business – your bank balance will change as you buy and sell your products or services.

Your closing balance will be therefore different at the end of the year than your opening balance (even if you are doing nothing.. you’ll probably incur some banking cost and interest).

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There is one very important question though that the Balance sheet will NOT answer:

How did you make the Profit (or Loss)?

To answer this question – you’ll need to look into the Income statement or Profit & Loss account (Winst- en Verliesrekening) – which I explain in What is a Profit and Loss Statement? A Plain-English Guide for Dutch Entrepreneurs.

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