The Balance Sheet
- Anthony J. Charles, EA
- Mar 9
- 7 min read
If your entity files a business tax return, you may have noticed an obscure question. It asks whether the business meets both of the following conditions:
Total receipts for the year were less than $250,000, and
Total assets at the end of the year were less than $250,000.
If the answer is yes, the business is not required to complete Schedule L. Schedule L is the balance sheet of the business, as reported on a tax return. Even when it is not legally required, I usually prepare Schedule L as a matter of routine practice. Maintaining a balance sheet makes it much easier to keep accurate records and avoids the unpleasant task of reconstructing financial statements later.
This article is written for business owners who may not know what a balance sheet is, or how to prepare one. Let’s start with the basics. Every business has two primary financial statements:
Profit & Loss Statement (P&L)
Balance Sheet
The P&L measures how well a business performs over a period of time. For example, a month, quarter, or year. The balance sheet, on the other hand, is a snapshot of the business’s financial position on a specific date. It shows what the business owns, what it owes, and what is left over for the owners. Think of it as a net worth report. Schedule L actually contains two balance sheets: one at the beginning of the tax year, and one at the end of the tax year. The beginning-of-year balance sheet is simply last year’s ending balance sheet carried forward. In the very first year of business, the beginning-of-year balance sheet is easy: all zeros. Keeping balance sheets every year prevents the need to rebuild them later when records are inaccurate or incomplete. Every balance sheet is built on one simple equation:
Assets – Liabilities = Equity
This is often rearranged into the more familiar form seen on balance sheets:
Assets = Liabilities + Equity
This equation must always balance. If it does not, something in the bookkeeping is incorrect.
A balance sheet therefore has two equal parts:
Assets
Liabilities & Equity
Let's take a closer look at each part of a balance sheet.
Assets
Assets are things the business owns. They are listed at the top of the balance sheet in descending order of liquidity, meaning how quickly they can be converted to cash. At the very top is cash:
Cash in the register
Cash in business bank accounts
Cash equivalents include short-term, highly liquid investments, such as money market funds. If customers owe your business money, those amounts are called accounts receivable. Accounts receivable and payable are seen with businesses who use the accrual method of accounting. Receivables represent revenue earned but not yet collected. Businesses that sell goods must track inventory. Inventory is generally reported at its wholesale cost, not retail value. Keeping accurate inventory records is essential because inventory directly affects the calculation of Cost of Goods Sold (COGS) on the P&L (not applicable for most service-based businesses). Current Assets are assets that can be sold, used, or converted to cash within one year. Examples include:
Cash
Cash Equivalents
Receivables
Inventory
Short-term investments
Prepaid expenses
Non-current assets are assets that are not expected to be converted to cash within one year. Examples include:
Fixed Assets
Land
Long-term investments
Long-term loans made to others
Goodwill
Certain prepaid items
Other intangible assets that are amortized over time
Fixed assets are also called Property, Plant & Equipment (PPE) such as:
Buildings
Equipment
Machinery
Vehicles
Furniture
These assets are recorded at their original cost (unadjusted basis). Below each PPE asset is a contra-asset account called Accumulated Depreciation, which tracks all depreciation taken on that asset over time. The remaining value is called the book value.
Both assets and liabilities can move between their current and non-current classifications. For example, imagine a business prepays $9,000 in loan costs for a 30-year loan. Each year, $300 of those costs are amortized. That means:
$300 is considered a current asset
$8,700 remains a non-current asset
If the loan is scheduled to be refinanced within a year, the remaining $8,700 could be reclassified as a current asset. When the refinance occurs, the remaining loan costs may be written off as an expense. Sometimes, for tax reporting simplicity, you don’t need to allocate your assets and liabilities between current and non-current forms. At the bottom of the asset section, all of the business’s assets are added up and reported as Total Assets.
Liabilities
Below the assets section is the liabilities section. Liabilities represent money the business owes to others. For example, if a business takes out a $1,000 loan, two entries are created on the balance sheet:
$1,000 cash (asset)
$1,000 loan payable (liability)
You can see how getting a loan does not create equity, since $1,000 asset minus $1,000 liability equals $0 in equity. Current liabilities are obligations that must be paid within one year. Examples include:
Accounts payable
Wages payable
Sales tax payable
Credit card balances
Short-term loans
These appear at the top of the liabilities section because they are the most immediate obligations. Liabilities that will not be paid within one year are classified as non-current liabilities (long-term liabilities). Examples include:
Business loans
Mortgages
Bonds payable
Sometimes, a liability can be split between current and non-current portions, same as with assets. For example, a loan payment due within one year may be classified as current, while the remaining balance stays non-current. For simplicity, many small businesses treat credit card balances as current liabilities. Interest paid on a debt is recorded on the P&L as an expense. The principal portion of a loan payment reduces the liability on the balance sheet. Principal payments are not deductible expenses. At the bottom of the liability section, the total is added up.
Equity
The final section of the balance sheet is equity, which represents the owner’s stake in the business. Equity is essentially what would remain if the business sold all its assets and paid all its liabilities. I like to think of equity as what the business owes to its owners. A simple analogy is home equity. If you sell your house and pay off the mortgage, the money left over is your equity. When an owner contributes personal funds to the business, it increases equity. For example, if an owner deposits $20 into the business bank account, then:
Assets increase by $20
Equity increases by $20
When money or property is taken out of the business by the owner, it is called a distribution.
Distributions reduce equity. Dividends paid by C corporations are a special type of distributions. Corporate balance sheets often include:
Capital Stock – the value received when shares are issued at par value
Additional Paid-In Capital (APIC) – amounts received above par value
Retained Earnings – accumulated profits that remain in the business
Profits increase retained earnings. Losses reduce retained earnings. Public corporations may also report an account called Treasury Stock, which reduces shareholder equity.
Add up the Liabilities and Equity and make sure both together equal Assets. If they don't match, you have an Unbalanced Sheet, not a Balance[d] Sheet.
The Accounting Equation
The accounting equation can be expanded to show how income flows into equity. Start with the basic equation:
Assets - Liabilities = Equity
Equity can be expressed as:
Equity = Contributions - Distributions + Retained Earnings
Retained earnings are derived from business operations:
Retained Earnings = Revenue - Expenses
Substituting these into the equation gives:
Assets - Liabilities = Contributions - Distributions + Revenue - Expenses
Rename Contributions to Equity and rearrange the terms:
Distributions + Expenses + Assets = Liabilities + Equity + Revenue
This is called the DEALER form of the expanded accounting equation. Contributions was renamed Equity to make the mnemonic work. This expanded equation shows how the balance sheet and the P&L are mathematically linked.
Source of Information for the Balance Sheet
If you are not using bookkeeping software like QuickBooks Online, balance sheet information must be gathered from various records. You can determine asset balances by reviewing:
Bank statements
Cash counts
Inventory
Invoices and purchase receipts
Depreciation schedules
Inventory should ideally be tracked by a point-of-sale (POS) system, with a physical inventory count at least once per year to detect shrinkage, theft, or damage. Liabilities can usually be verified through:
Loan statements
Credit card statements
Amortization schedules
Some liabilities may require manual tracking, particularly informal loans or loans from family members or shareholders. Equity requires continuous tracking:
Capital contributions
Owner distributions
P&L statements
Partnerships must track these amounts for each partner individually. Before computers, businesses recorded every transaction in paper journals and ledgers. Think of Scrooge from A Christmas Carol writing entries by hand. Today, bookkeeping software automates much of the process. Bank accounts and credit cards can be linked directly to accounting systems like QuickBooks Online, and transactions can often be categorized automatically using rules and algorithms. Even with modern software, however, business owners must still review transactions and maintain accurate records.
In my practice, I have often had to reconstruct balance sheets for businesses that failed to keep good records. Reconstructing a balance sheet is part science and part art. You start with what you know, then use the accounting equation to determine what is missing. Sometimes the discrepancy comes down to something simple—like an owner forgetting to record capital contributions. When everything else is correct, the accounting equation can reveal the missing amount needed to balance the books.
I have also included files below containing two sample balance sheets:
The small-business example shows both unadjusted asset cost and accumulated depreciation, similar to how Schedule L reports asset information. The large-company example is an actual balance sheet from Apple Inc. public filings and reflects a more traditional corporate balance sheet format. If you understand how a balance sheet works, you already understand one of the most powerful tools for managing a business. It tells you exactly what the business owns, what it owes, and what it is truly worth.
Conclusion
In order to report your company's balance sheet on its tax return, I usually need the following items at a minimum:
How much cash did your business own on December 31? Look at bank statements
If you have inventory, you need to find your Ending Inventory.
If you have Fixed Assets that are not recorded, then you need for each asset, a description of the asset, the date it was placed in service (ready and available for use in the business, and its unadjusted cost basis (total cost of acquiring the asset). Look for the invoice and receipt of the asset.
Look at your credit card statements to determine your current liabilities as of December 31
For any loans that don't have clear documentation, you'll need a description of the loan, principal amount, interest rate, term, date the loan was taken out, payment periodicity, and any special terms (is it an interest-only loan or a variable rate note?)
Amount of Capital Contributions, and who made them (if it's a partnership). Look at bank statements for money received from owner's personal accounts.
Amount of Distributions, and who made them (if it's a partnership). Look at bank statements for money getting transferred to a personal account
