Guide
How to read a balance sheet without an accounting degree
The P&L says whether last month made money. The balance sheet says whether the business is sound.
Reviewed by Darren Lim, US CPALicence CPA.742536028 min read
Most contractors read their P&L and never open the balance sheet. That is backwards for a contracting business, because the balance sheet is where the problems that actually sink companies show up first.
The P&L tells you whether last month made money. The balance sheet tells you whether the business is sound — and a business can be profitable and unsound at the same time. Here is how to read it without an accounting degree.
What it is
The P&L covers a period — a month, a year. The balance sheet is a single moment: what the business owns, what it owes, and what is left over, on one specific day.
Three sections, and they always tie together:
Assets = Liabilities + Equity
what you own = what you owe + what's yours
That is the whole thing. Everything below is learning to read the three parts.
Assets — what you own or are owed
Top of the sheet, roughly in order of how quickly each turns into cash.
Cash. Real money in the accounts. The one number people check and the only one that cannot be argued with.
Accounts receivable. Money customers owe you. Healthy up to a point — past it, a large receivables figure means you have done a lot of work you have not been paid for, which is profit on the P&L and nothing in the bank.
Retainage receivable, if you do commercial or new-construction work. Money that is earned and contractually yours but held back until the job is signed off. It belongs in its own line, not buried in ordinary receivables, because it is not late — it is held, and chasing it is pointless until the release conditions are met.
Work in progress, on longer jobs. The value of work performed but not yet billed. WIP is where the margin on a half-finished job lives.
Inventory and equipment. Trucks, tools, the stock on the shelf, less depreciation.
Liabilities — what you owe
Accounts payable. Bills you have not paid — suppliers, subs.
Credit cards and the line of credit. Short-term debt. A line of credit that never comes back to zero is a warning: the business is using borrowing to cover a gap that operations are not filling.
Payroll taxes payable. Watch this one. It should clear to zero after each deposit. A payroll tax liability that only grows is the single earliest sign of a cash problem, and the withheld portion is trust fund money — the most dangerous balance on the sheet to let build.
Customer deposits. Money taken for work not yet done. It is a liability, not income — you owe the work — and treating deposits as revenue is how a business feels flush right before it has to deliver everything it was paid for.
Billings in excess of costs. Overbilling on construction jobs. It flatters cash: you have invoiced ahead of the work, so the bank looks healthy while you owe that work back.
Equity — what is actually yours
Assets minus liabilities. What would be left if you collected everything owed to you and paid everything you owe. Retained earnings, contributions, and draws sit here. If equity is shrinking while the P&L shows profit, the profit is leaving as draws faster than it is being made.
The four things to actually look at each month
You do not read every line. You read four relationships.
1. Current ratio — can you cover the next twelve months? Current assets divided by current liabilities. Below 1.0 means what falls due within a year is more than what you can turn into cash within a year, which is a squeeze coming whether or not the P&L looks fine.
2. Cash against payroll-tax liability. If the tax payable line is climbing and cash is not, the business is funding itself out of money it is holding for the government. Find it here before it becomes a notice.
3. Receivables against revenue. If receivables are growing faster than sales, you are selling work and financing your customers to do it. Days sales outstanding puts a number on how long.
4. Anything negative that should never be negative. A negative asset, a payroll liability that went the wrong way, an "ask my accountant" account with a balance in it. Negatives that should not exist are usually a bookkeeping error hiding something real.
Why the balance sheet catches what the P&L misses
Profitable-but-broke is the classic contracting failure, and it is invisible on a P&L. The income statement can show a good year while receivables balloon, deposits get spent, retainage piles up uncollected and the tax liability grows. Every one of those shows on the balance sheet, on the day it starts.
Which is why, if you ask your bookkeeper for one thing each month, ask them to walk you through the balance sheet — not just hand you the P&L. Here is how to read the P&L to go with it.
Related
How we do this
We build this into your books. Starting with a month that costs you nothing.
A balance sheet that ties every month, with retainage, work in progress, deposits and payroll liabilities each on their own line, plus a plain-English walk through what changed — not just a P&L handed over without comment.
- Every transaction categorized, accounts reconciled, the month closed
- Reviewed and signed by Darren Lim, US CPA — licence CPA.74253602
- The Two-Day Guarantee: Your first month back in two days, or the next month is free.
Profitable-but-broke is the classic contracting failure and it is invisible on a P&L. Every warning sign shows on the balance sheet on the day it starts, which is why a month of properly built books is worth more than any year-end summary.