The profit and loss tells you how the business performed over a period. The balance sheet tells you where it stands on a particular day. It lists what the business owns, what it owes and what is left for the owners. Lenders, investors and buyers read it first, and owners who understand it make better decisions about stock, borrowing and cash.

The basic equation

Every balance sheet follows one rule:

Assets = Liabilities + Equity

What the business has (assets) was paid for either by borrowing (liabilities) or by the owners (equity). The two sides must be equal, which is why it is called a balance sheet.

Assets

Assets are listed from the most liquid to the least.

  • Current assets turn into cash within a year: cash and bank balances, M-Pesa float, accounts receivable (customers who owe you), stock and prepaid expenses.
  • Non-current (fixed) assets are used for years: equipment, vehicles, furniture, buildings, shown at cost less accumulated depreciation. The depreciation schedule workbook and fixed assets and capital allowances explained cover them.

Liabilities

  • Current liabilities are due within a year: supplier invoices, accrued expenses, VAT, PAYE and other taxes payable, short-term loans and the current portion of long-term loans. See the supplier bills and payables tracker.
  • Long-term liabilities are due later: bank loans, asset finance.

Equity

Equity is the owners' stake: the capital put in, plus profits kept in the business, less amounts taken out as drawings or dividends. The owner drawings and capital account tracker maintains it. For companies, the retained earnings figure carries the profit forward each year: see dividends and paying yourself from a company.

A simple example

Assets KES Liabilities and equity KES
Cash and M-Pesa 150,000 Suppliers owed 120,000
Customers owe 200,000 Taxes payable 40,000
Stock 300,000 Bank loan 400,000
Equipment (net) 500,000 Owner's equity 590,000
Total 1,150,000 Total 1,150,000

Current assets are KES 650,000 and current liabilities are KES 160,000. The business can pay its short-term debts four times over, which looks healthy. The loan is large against equity, so lenders will check the cash flow.

Ratios worth knowing

  • Current ratio = current assets ÷ current liabilities. Above 1.5 is usually comfortable.
  • Quick ratio = (current assets less stock) ÷ current liabilities, which shows if you can pay bills without selling stock.
  • Debt to equity = total liabilities ÷ equity. High ratios mean heavy borrowing.
  • Debtor days = receivables ÷ sales × days in the period. Rising days mean customers pay later: invoicing and getting paid on time.
  • Stock days = stock ÷ cost of sales × days. See inventory management basics.

The balance sheet shows the tax you owe: VAT, PAYE and corporation tax payable appear as liabilities until paid, so a growing taxes payable balance is a warning. Asset values drive depreciation and capital allowances. A tax computation starts from the profit in the accounts and adjusts it. Use the corporation tax calculator and the corporation tax computation workbook for the steps.

Build one

Start with the balance sheet template and the trial balance template. You need a list of balances at the end of the month: bank and M-Pesa, receivables, stock, assets, payables and loans. Reconcile cash first, as shown in bank reconciliation step by step.

Pair it with the profit and loss

Read both together: the profit and loss shows if the business earns, the balance sheet shows if it can survive and grow. A profitable business can still run out of cash if profits are tied up in stock and unpaid invoices. Compare the two in how to read a profit and loss statement and plan cash with a cash flow forecast.

Frequently asked questions

How often should I prepare a balance sheet? Monthly if you can, and at least at each year-end and before applying for a loan.

Why is my balance sheet not balancing? Usually from a missing entry, a double entry on one side or a transposed figure. Reconcile the bank first, then check the trial balance.

Is the owner's loan a liability or equity? A loan the owner expects to be repaid is a liability. Money put in permanently as capital is equity.

Do sole traders need a balance sheet? It is not required for turnover tax, but lenders ask for one and it helps you manage the business.