Who this is for
- US small business owners whose balance sheet has negative balances, a plug or a large unexplained equity amount
- Sole proprietors, partnerships and corporations preparing a balance sheet for a lender, a preparer or Schedule L
Not covered here
- Clearing a large or negative opening balance equity, undeposited funds or shareholder loan balance
- Completing Schedule L line by line or choosing between cash and accrual accounting
- Statements a bank or the SBA requires for a specific loan
What does a small business balance sheet show?
A small business balance sheet shows what the business owns, what it owes and what is left for the owners on one date. The SEC calls it a snapshot of assets, liabilities and equity, and the two sides must balance: assets equal liabilities plus equity. For a sole proprietor, the IRS describes the same three parts: assets, liabilities and the owner's equity in the business.
A balance sheet that balances can still be wrong. Double-entry books balance by design, because every entry has a debit and a credit (Publication 583). So "it balances" proves the arithmetic, not the contents. Cases that are not simple:
- A plug: an amount posted to equity or a holding account only to make the totals agree.
- Cash that was never reconciled to the bank.
- A loan, equipment or (if your books record them) unpaid bills missing from the sheet.
- Opening balances that do not match last year's filed return or closing balance sheet.
To check a balance sheet, gather:
- the year-end balance sheet and a trial balance (the balance of every account)
- each bank, card and loan statement at the year-end date
- last year's filed return and closing balance sheet
- lists of unpaid customer invoices and unpaid bills, if your books record them
If a lender, preparer or CPA is waiting on the sheet and it has a plug, negative accounts or an equity balance you cannot explain, or it does not match last year's return, that is a case for a professional; see Different for you? at the end.
How do I fill out a small business balance sheet, and which lines belong on it?
To fill one out, list what the business owns, list what it owes, and the difference is equity, all on one date such as year-end. Partnership and corporation returns usually include a balance sheet from the books as Schedule L (Form 1120-S, Form 1065), and its line list is a useful checklist for any small business.
| Part | Line | What belongs there | What it should match |
|---|---|---|---|
| Assets | Cash | Business bank accounts and cash on hand | Each bank statement, after reconciling |
| Assets | Accounts receivable | Money customers owe for work already billed, less any amount you do not expect to collect | The unpaid-invoice list |
| Assets | Inventory | Goods held for sale | A year-end count or stock records |
| Assets | Buildings, equipment and other depreciable assets, less accumulated depreciation | What the business owns for use over several years, at cost less depreciation to date | Purchase invoices, closing statements and the depreciation schedule |
| Assets | Land and other assets | Land the business owns, prepaid expenses and deposits | Closing statement, invoices and deposit receipts |
| Assets | Loans to owners | Money the business lent to an owner or partner | A written record of each advance |
| Liabilities | Accounts payable | Bills received and not yet paid | The unpaid-bill list |
| Liabilities | Loans, mortgages and notes payable, due within a year and due later | Bank, equipment, property and owner loans, at the unpaid principal | The lender's year-end statement |
| Liabilities | Other current liabilities | Card balances, sales tax and payroll tax owed | Card statements and tax returns |
| Equity | Owner's equity, partners' capital accounts, or stock and retained earnings | What the owners put in, plus profit kept, minus what they took out | Last year's closing equity, plus this year's profit or loss and money the owners put in, less what they took out; explain any other change |
On books kept on the cash method, receivables and payables may be zero by design: you report income when you receive it and usually deduct expenses when you pay them (Publication 583). Accrual books show both; see cash or accrual for a small business.
Publication 583 calls the difference between assets and liabilities net worth. Because equity falls out as a difference, it proves nothing by itself; check it against the owner's record of money put in, money taken out and profit kept. A sole proprietor has one owner's account. A partnership keeps a capital account for each partner. A corporation shows capital stock, paid-in capital and retained earnings. For an LLC, see equity accounts for an LLC.
How can I tell whether my balance sheet is right?
A balance sheet is more likely to be right when it balances and each major line ties to a record outside the books. Four ties catch the common errors:
| Tie | Compare to | A gap usually points to |
|---|---|---|
| Cash | The year-end bank reconciliation: statement balance, plus deposits in transit, less outstanding checks | A difference left unexplained can mean months not reconciled, a deposit entered twice or payments never entered; timing items that clear later need no entry |
| Loans | The lender's year-end statement | A loan that was never recorded, or payments booked as expenses |
| Receivables and payables, on accrual books | The unpaid-invoice and unpaid-bill lists | Payments matched to the wrong invoice, bills never entered |
| Opening balances | Last year's closing balance sheet, and Schedule L on last year's return if one was filed | Changes to a closed year, or opening balances entered as plugs |
The IRS advises reconciling the checking account each month so that the bank statement, the checkbook and the books agree. It lists what reconciling does: verify how much money is in the account, confirm the books reflect all bank charges, and correct errors. A bank feed alone does not do this; see bank feeds are not reconciliation.
A figure you cannot trace to a statement, invoice or prior return may be a plug.
Why does my balance sheet show strange numbers?
Strange numbers on a balance sheet usually come from cash that was never reconciled, a loan or asset missing from the books, owner money in the wrong account, or opening balances that differ from last year's return. Match what you see to the likely cause:
| What you see | Usual cause | Next step |
|---|---|---|
| A negative bank or cash balance | Payments entered without the deposit that funded them, a missing deposit, or an account never reconciled | Compare to the statement; if the bank shows a positive balance, look for missing or wrong entries, or checks that have not cleared |
| A negative receivable | A customer payment entered twice, matched to the wrong customer, or a refund not matched | Open the customer's account and compare to the invoices |
| A card balance that is negative or not the statement balance | Payments or charges entered twice, or card payments booked as expenses | Credit card payments in the books |
| Assets do not equal liabilities plus equity | Books kept in a spreadsheet, or data moved from other software | Find the entry or row with no matching other side; see switching accounting software mid-year if the books were moved |
| A large or negative equity balance that is not profit or owner activity | A plug, or opening balances never assigned to the right accounts | Opening balance equity |
| A holding account for money received but not deposited that keeps growing | Payments never matched to the bank deposit that contains them | Undeposited funds balance |
| Opening equity that differs from last year's closing books or filed return | Entries after the return was prepared, edits to a closed year, owner money in the wrong place | Retained earnings that do not match last year's return |
| Owner's equity below zero | Draws or distributions above profit, past losses, a missing contribution | Negative owner's equity |
| A large loan to a shareholder | Owner money out recorded as a loan | Loans to shareholders |
| No loan, with loan payments in expenses | The loan was never recorded | Recording a business loan |
| Equipment in expenses, or no accumulated depreciation | Equipment bought but never put on the sheet, unless the books' own policy expenses it | Rebuilding a missing depreciation schedule |
| Payroll or sales tax owed that never goes down | Payments recorded somewhere other than against the liability, or the tax was never paid; unpaid withheld payroll tax can make a responsible person personally liable | Payroll liabilities that will not clear |
The Schedule C instructions for other expenses say not to include the cost of business equipment or furniture, or personal, living and family expenses (Schedule C instructions). A business that makes the de minimis safe harbor election may instead deduct small equipment purchases right away as other expenses, if its books expense them too (Publication 334); see expense or capitalize small purchases. The Form 1065 instructions say a partnership's assets may not be netted against liabilities or reported as a negative number (Form 1065 instructions), so before Schedule L is filled in, a negative asset needs a cause: an entry error, or a real overdraft or credit balance that belongs as a liability.
Where does money I put into or take out of the business belong?
Money an owner puts into or takes out of a business generally belongs in equity or loan accounts on the balance sheet, not in income or expenses; which one depends on the facts and the entity. The IRS says money borrowed through a bona fide loan is not income (Publication 334). It also suggests noting the source of each deposit: business income, personal funds or a loan (Publication 583).
| Owner activity | Where it goes | Not |
|---|---|---|
| The owner puts money in to stay in the business | Equity: owner's capital, partner capital account, or stock and paid-in capital | Income |
| The owner lends money to the business | A liability: loan from owner, partner or shareholder (its own line on Schedule L) | Income; repayment is not an expense |
| The owner takes out profit | Equity: a draw, or a distribution for a corporation | An expense |
| The business lends money to an owner, or pays an owner's personal bill | A loan to the owner, partner or shareholder (its own line on Schedule L), or a draw or distribution, depending on the entity and the facts | A business expense |
Pay to an owner for work done for the business can be wages or a guaranteed payment rather than a draw or distribution. An S corporation must treat payments to an officer as wages to the extent they are reasonable compensation for services (Form 1120-S instructions), and a partnership may deduct guaranteed payments to a partner for services (Form 1065 instructions). See recording S corporation distributions and guaranteed payments vs partner draws.
For a sole proprietor, Publication 334 describes a separate drawing account for business income withdrawn for personal and family expenses, which are usually not deductible. Whether owner money in is a contribution or a loan turns on the facts; see contribution or loan to an LLC and recording owner's draws. If personal and business money went through the same account, see fixing commingled business and personal funds.
Do I need a balance sheet, and who asks for one?
A lender or investor often asks for a balance sheet, a partnership or corporation return may need one as Schedule L, and a sole proprietor's Schedule C has none. The SBA says an established business includes income statements, balance sheets and cash flow statements for the last three to five years in a traditional business plan, which lenders and investors commonly request. The IRS adds that financial statements help in dealing with a bank or creditors. For what a lender wants, see financial statements for a bank loan.
A partnership or corporation may skip Schedule L only when it passes a small-return test on its own form, answered on Schedule B for Forms 1065 and 1120-S and on Schedule K for Form 1120. The test uses total receipts and total assets. Total receipts is wider than sales: it adds other income, and on Forms 1065 and 1120-S also income reported on Schedule K and rental income from Form 8825 (Form 1065 instructions, Form 1120-S instructions). The limits and extra conditions differ by form and year, so read the form you file; Schedule L on a corporate return covers them. Skipping Schedule L does not change what a lender or preparer asks for.
What should the tax return's balance sheet agree with?
Schedule L should agree with the entity's books and records. The instructions for Form 1120, Form 1120-S and Form 1065 all say so. A partnership must attach a statement explaining any differences.
Schedule L shows the balance sheet at the start and end of the year. The Form 1065 instructions say total assets at the start of the year generally must equal total assets at the close of the prior year, and a partnership attaches a statement if they differ. On an S corporation return, loans from shareholders on Schedule L generally should reconcile to the shareholder loan totals on the Schedules K-1 (Form 1120-S instructions). A sole proprietor's return has no Schedule L, so there is no filed balance sheet to match; compare opening balances with last year's closing balance sheet instead. If your books do not open where last year's return closed, start with retained earnings that do not match last year's return.
What do I do when the numbers will not tie out?
Work in this order, because each step depends on the one before:
- Reconcile cash. Reconcile each bank account to its statement (Publication 583) and each card account the same way, starting with the oldest unreconciled month so a wrong balance is not carried forward.
- Add what is missing. Record loans and equipment, and on accrual books unpaid bills, from lender statements and invoices, and move loan principal out of expenses. Move equipment out too if the books capitalize it: it belongs at cost with accumulated depreciation, even when the return deducted its cost under section 179 or bonus depreciation, because book and tax depreciation can differ (Form 1120-S, Schedule M-1). Equipment stays in expenses only when the books' policy expenses it, as the de minimis safe harbor requires (Publication 334).
- Move owner money. Decide from the documents whether each owner transaction was a contribution, a loan or a draw, then post it to equity or a loan account.
- Compare opening balances to last year's closing balance sheet, and to Schedule L on last year's return if one was filed, before changing this year. A gap at the start of the year usually comes from before this year or from an edit to a closed period; find which before changing anything.
- Trace every plug and holding balance to documents. Do not post a new entry only to make the sheet balance; list what you cannot explain.
Some cases need professional judgment, because fixing the balance sheet can change profit or equity for earlier years. If a fix changes a prior year's profit, the return filed for that year may need review. Professional help fits when more than one year is off, a lender or preparer is waiting, a notice has arrived, Schedule L must agree with a filed return, or a corporation has shareholder loans.
Example
These examples are illustrative; all figures are in US dollars.
Cash is higher than the bank
A landscaper's balance sheet shows $26,500 in cash. The bank statement shows $18,000, a gap of $8,500. Reconciling back to the oldest unreconciled month finds two causes: a $6,000 customer deposit entered twice, once from the bank import and once by hand, and $2,500 of supplier payments that cleared the bank but were never entered. After both are fixed, cash agrees with the bank. The duplicate deposit may also have been counted as income, so the profit and loss needs a second look.
A loan is missing
An LLC borrowed $42,000 at the start of the year to buy equipment. The lender paid the seller directly, so neither the equipment nor the loan was ever entered. Payments of $8,400 for the year sit in expenses: $1,800 of interest and $6,600 of principal. The corrected balance sheet shows equipment at $42,000 less depreciation and a loan of $35,400, matching the lender's year-end statement. Only the $1,800 of interest stays in expenses. Moving the $6,600 of principal out raises profit and equity by $6,600 before depreciation.
Equity is off from last year's return
An S corporation that files Schedule L has books that open this year with retained earnings of $48,000. Schedule L on last year's filed return shows $54,000 at year-end. The $6,000 gap exists before the first entry of this year. The next step is to compare last year's closing balances with this year's opening balances account by account, to find what changed since the return was prepared.
Different for you?
- Your lender, preparer or CPA has asked for a balance sheet, and yours has a plug, a large unexplained equity balance, negative accounts or does not tie to last year's return: the accounts and opening balances usually need tracing to documents before the sheet goes to a lender or into Schedule L; see bookkeeping cleanup help.
- A large or negative equity balance came from opening balances: see opening balance equity.
- Money received but not deposited keeps piling up in a holding account: see undeposited funds balance.
- Owner's equity has gone negative: see negative owner's equity.
- Your corporation's balance sheet shows a large loan to a shareholder: see loans to shareholders.
- Your profit, not your balance sheet, looks wrong: see profit and loss statement looks wrong.
- Fixing the sheet would change profit or equity in a year you already filed, or a notice has arrived: the earlier return may need review before the books change; see bookkeeping help.
- The business is owned or funded from abroad, such as a US subsidiary of a foreign parent: see books for a US subsidiary of a foreign parent.
- Several years of books are behind or do not tie to filed returns: see catching up on overdue books and get bookkeeping help.
Primary sources
- SEC: Beginners' Guide to Financial Statements
- IRS: Publication 583, Starting a Business and Keeping Records
- IRS: Publication 334, Tax Guide for Small Business
- IRS: Instructions for Schedule C (Form 1040)
- IRS: Schedule C (Form 1040)
- IRS: Form 1065
- IRS: Instructions for Form 1065
- IRS: Form 1120-S
- IRS: Instructions for Form 1120-S
- IRS: Form 1120
- IRS: Instructions for Form 1120
- IRS: Employment taxes and the trust fund recovery penalty
- SBA: Write your business plan
About this guide
Published by Cloud Accounting under standing professional approval. This version has no separately recorded personal review. It explains general rules for the tax year shown. It is not advice for your situation.
Changes
- : First published.