How a Founder Reads a Balance Sheet
Your accountant sends the monthly pack. The P&L you can read: revenue, costs, profit, done. The balance sheet is the page you skip. It has lines nobody asked for, a couple of numbers in brackets, and two totals that match for reasons no one explained. Yet this is the page that says whether the company could survive a slow quarter, and it takes about ten minutes a month to read properly.
Three blocks, one equation
A balance sheet is a photograph of the company on one date, usually the last day of the month. It has three blocks. Assets are what the company owns or is owed: cash, unpaid client invoices, laptops. Liabilities are what the company owes: supplier bills, salaries and taxes not yet paid, work that clients have already paid for. Equity is the difference, the part that belongs to the owners.
The equation is always the same: assets equal liabilities plus equity. If the two sides do not match, something was posted wrong, and that is the first thing to check. In a double-entry ledger they cannot drift apart, because every posting touches both sides or two lines on the same side.
For a services company the picture is simple. There is no inventory and no factory. Assets are mostly cash and receivables, plus a small pile of hardware. Liabilities are mostly payables, payroll accruals and deferred revenue. Equity is share capital plus whatever profit has been kept in the business over the years.
Why some lines are negative
The numbers in brackets confuse most first-time readers. They are contra accounts: lines that sit inside a block but reduce it. The common one in a services firm is accumulated depreciation, which sits under fixed assets.
Take a laptop fleet. Twelve laptops bought at EUR 1,800 each go on the books at cost, EUR 21,600. That cost is not an expense on the day of purchase; it becomes an expense gradually, over the useful life, say three years. Each month EUR 600 of depreciation hits the P&L, and the same EUR 600 is added to accumulated depreciation on the balance sheet. After eighteen months the balance sheet shows:
- Laptops and equipment, at cost: EUR 21,600
- Accumulated depreciation: (EUR 10,800)
- Net book value: EUR 10,800
The cost line never changes until you sell or scrap a machine. The contra line grows every month. Net book value is what the fleet is "worth" in accounting terms, which is not the resale price, just the part of the original cost not yet expensed.
The other common contra line is the allowance for doubtful receivables, shown in brackets under trade receivables. If you have decided that EUR 4,000 of client invoices will probably never be collected, the allowance reduces receivables to the amount you actually expect. Equity can also go negative, when accumulated losses exceed the capital paid in. That one is a warning sign, not a bookkeeping detail.
Receivables are a promise, cash is a fact
A large receivables line feels good. Clients owe you money, business is happening. But receivables do not pay salaries. Only the cash line does, and the gap between the two is where services companies get into trouble.
Read receivables together with the aging schedule. If EUR 62,000 is outstanding and EUR 50,000 of it is under 30 days, you are fine. If EUR 25,000 of it is over 60 days, you have a collections problem that the balance sheet total hides. A quick check: divide receivables by average monthly revenue and multiply by 30. At EUR 62,000 of receivables and EUR 55,000 of monthly revenue, clients take about 34 days to pay on average. If that number climbs month after month, act before it reaches the cash line.
Deferred revenue: money you hold but have not earned
Retainers paid in advance create a line that surprises founders because it makes cash look better than it is. A client pays EUR 9,000 on 2 January for a first-quarter retainer. Cash goes up by EUR 9,000. Revenue does not. Instead, a liability called deferred revenue goes up by EUR 9,000, because you now owe the client three months of work.
Each month EUR 3,000 moves out of deferred revenue and into revenue as the work is delivered. At the end of January the liability is EUR 6,000; at the end of March it is zero. If the client cancels in February, part of that liability may become a refund, which is exactly why it is shown as a debt and not as income.
The practical rule: when you look at the cash balance, subtract deferred revenue before you decide how much room you have. That money is in your account, but it belongs to work you have not done yet.
Worked example: a 14-person agency at 31 January
Here is a simplified balance sheet for a design and development agency with fourteen people, EUR 55,000 of monthly revenue and a payroll of about EUR 38,000 per month. Figures are in EUR.
| Line | Amount |
|---|---|
| Cash at bank | 84,500 |
| Trade receivables | 62,000 |
| Allowance for doubtful receivables | (4,000) |
| Laptops and equipment, at cost | 21,600 |
| Accumulated depreciation | (10,800) |
| Total assets | 153,300 |
| Trade payables | 18,700 |
| Payroll and taxes due | 27,400 |
| Deferred revenue (retainers) | 12,000 |
| Total liabilities | 58,100 |
| Share capital | 5,000 |
| Retained earnings | 90,200 |
| Total equity | 95,200 |
Liabilities plus equity: 58,100 + 95,200 = 153,300. It balances. Now read it the way a founder should.
Cash of EUR 84,500 looks like more than two months of payroll. But EUR 27,400 of payroll and taxes is already due, and EUR 12,000 of the cash belongs to retainers not yet delivered. Cash that is genuinely free is closer to EUR 45,000, about five weeks of payroll. Comfortable, not lavish.
Receivables of EUR 62,000 less the EUR 4,000 allowance is EUR 58,000 of expected collections, a little over one month of revenue. Fine, as long as the aging report confirms most of it is recent. Working capital (current assets minus current liabilities) is EUR 142,500 minus EUR 58,100, or EUR 84,400. The company can meet its short-term obligations with room to spare.
The laptop fleet is half depreciated. In eighteen months it will be at zero on the books and probably due for replacement, so the founder can start a replacement budget now instead of being surprised.
What to check every month
- Cash against the next payroll date, after subtracting deferred revenue and payroll already accrued.
- Receivables against the aging schedule: what share is over 60 days, and which clients.
- Deferred revenue against delivery: is the work being done at the pace the money is being recognized?
- Payables due within 30 days, so that nothing lands in the same week as salaries.
- Retained earnings trend: it should move by roughly the month's profit. If it jumps for another reason, ask why.
- That the balance sheet balances and agrees with the trial balance. In a system such as TridentERP every figure drills down to the trial balance, the account card and the source document, which turns "why is this number here" into a two-minute question instead of an email thread.
FAQ
Why does my profit not match the change in cash?
Because profit is recognized when work is done and cash moves when invoices are paid. Receivables, deferred revenue, payables and depreciation all sit between the two, and the balance sheet is where you see them.
Should I write off old receivables or keep them on the balance sheet?
Keep them, but book an allowance for the ones you doubt. That way receivables show what you expect to collect, and the loss hits the P&L in the month you accept it rather than years later.
Is negative equity a problem if the company is profitable now?
It means past losses have eaten the capital. Profitable months will rebuild it, but until it turns positive, lenders and larger clients running credit checks will read it as risk.
What to do next
- Pull last month's balance sheet and check that it balances and matches the trial balance.
- Compute free cash: bank balance minus deferred revenue minus payroll and taxes already due. Compare it with one month of payroll.
- Open the receivables aging and list every invoice over 60 days with an owner and a next action.
- List fixed assets with their net book value and note when each group reaches zero.
- Put a 15-minute balance sheet review in the calendar for the third working day of each month. If your current tool cannot produce one on demand, the live demo tour shows what a drill-down balance sheet looks like.
