What is a balance sheet?

Assets are what the business owns. Current assets are expected to be turned into cash or used within 12 months: cash at bank, trade receivables (less an allowance for expected credit losses), inventory (at the lower of cost and net realisable value) and prepayments. Non-current assets are held for longer: property, plant and equipment at cost less accumulated depreciation and impairment, and intangibles such as software and goodwill.

Liabilities are what it owes. Current liabilities fall due within 12 months: accounts payable, the current portion of loans, GST and tax payable, and provisions such as long service leave. Non-current liabilities include term loans and lease liabilities due after 12 months. Equity is what is left for the owners: share capital or owner's capital, retained earnings and any reserves or revaluation surplus.

A lender assessing a loan or overdraft looks first at liquidity and solvency. The current ratio (current assets divided by current liabilities) shows whether short-term obligations are covered, the quick ratio strips out inventory, working capital is current assets minus current liabilities, and debt-to-equity (total liabilities divided by total equity) shows how much of the business is financed by debt rather than by the owners. That last figure is often written into lending covenants.

Owners and directors use the same figures to decide on inventory purchases, capital expenditure and working capital policy, to value the business for a sale or investor discussion, and to reconcile BAS and GST alongside the profit and loss and cash flow statement. Showing the prior period beside the current one makes the trend easy to see, and loan statements should reconcile to the balances shown.

Most items are carried at historical cost less depreciation, so the balance sheet may not reflect what the assets would sell for today. Cut-off errors around the reporting date distort receivables, payables and retained earnings, and overstated inventory inflates assets while understating cost of sales. Since AASB 16, lessees recognise a right-of-use asset and a lease liability for almost all leases, with only short-term and low-value leases exempt, so off-balance-sheet items are now mostly guarantees, contingent liabilities and those exempt leases, disclosed in the notes.

Two common small-business errors are failing to split out the current portion of long-term loans, which makes the liquidity ratios wrong, and not reconciling bank accounts monthly. Missing owner drawings or related-party balances can misstate equity and liabilities, and unrecorded impairment or depreciation skews the whole position.