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The fundamental equation
Every balance sheet rests on a single equation: Assets = Liabilities + Shareholders' Equity. Assets are resources the company controls; liabilities are what it owes to others; equity is what would remain for shareholders if all liabilities were settled. Because of double-entry bookkeeping, the two sides must always balance — hence the name.
Unlike the P&L, which covers a period, the balance sheet is a photograph taken on a specific date, usually the last day of the financial year. Figures can look very different a week earlier or later depending on when large invoices are raised or payments clear.
Fixed and current assets
Non-current assets (fixed assets) are resources expected to generate value for more than twelve months: property, plant, machinery, vehicles, and intangibles such as goodwill or patents. They appear at cost less accumulated depreciation — so a machine bought three years ago may be carried at a fraction of its original purchase price.
Current assets are expected to convert to cash within twelve months: trade debtors (money customers owe you), stock, prepayments, and cash itself. The relationship between current assets and current liabilities tells you a great deal about short-term liquidity.
Current and long-term liabilities
Current liabilities fall due within twelve months and include trade creditors (what you owe suppliers), VAT due, PAYE/NIC payable, corporation tax owed, and the short-term portion of any loan. Non-current liabilities — term loans, finance leases extending beyond a year, deferred tax — sit beneath them.
Subtracting all liabilities from total assets produces net assets, which equals shareholders' equity. A positive and growing net assets figure generally signals a solvent, strengthening business. A negative figure — sometimes called net liabilities — warrants urgent attention and professional advice.
Shareholders' equity
The equity section shows how the company has been financed by its owners. It typically comprises share capital (the nominal value of shares issued), the share premium account (amounts paid above nominal value), and retained earnings (the cumulative total of all profits and losses since incorporation, less dividends paid out).
Retained earnings grow when the business is profitable and dividends are modest. A company with large retained earnings has a financial cushion; one with a significant retained loss is eroding its equity base. Either way, equity is the residual claim — shareholders are paid last if the business is wound up.
Key ratios derived from the balance sheet
Directors and lenders use several ratios to assess balance sheet health quickly. The current ratio (current assets ÷ current liabilities) indicates whether short-term obligations can be met from short-term resources — a ratio below 1 may signal liquidity pressure. The gearing ratio (total debt ÷ equity) shows how heavily the business relies on borrowed money relative to owner funding.
- Current ratio above 1.2–1.5 is generally considered comfortable for most trading businesses
- High gearing increases financial risk but can also amplify returns on equity
- Asset-light service businesses often carry very different ratios from manufacturers
- Always compare ratios against sector norms, not generic benchmarks
Confirm how any specific ratio should influence your decisions with your accountant or financial adviser.
Frequently asked questions
Can a profitable company have a weak balance sheet?
Yes. A company can generate steady profits while accumulating debt faster than it builds equity — for example, by paying large dividends or investing heavily in assets financed by borrowing. The balance sheet and P&L must be read together.
What does it mean if retained earnings are negative?
Negative retained earnings — often called accumulated losses — mean the company has lost more than it has ever earned after dividends. It does not automatically mean insolvency, but it does reduce net assets and should be discussed with your accountant.
Funding for UK limited companies
Credicorp lends to your company, not to you personally — short-term working capital with no personal guarantee. See what your business could access.