How to Read a Balance Sheet Like a CFO

Want to read a balance sheet like a CFO? Start here. In this video, Steve breaks down the balance sheet with a clear, high-level approach—no fluff, just what you need to know.

He walks through the three core components—assets, liabilities, and equity—and shows how they connect using the basic accounting formula. You’ll learn how to spot the difference between current and non-current items, understand key accounts like cash, inventory, PP&E, and debt, and uncover potential financial risks hiding in plain sight.

If balance sheets have ever felt confusing, this video will give you the clarity and confidence to read them like a pro.

TRANSCRIPT:

Hey, it's Steve. In this video, I'm going to show you how a balance sheet works from a CFO perspective. Now, I'm going to abbreviate and keep things really high level.

BS does not stand for what you think it might stand for. It represents the balance sheet. All right, here I go with explaining the balance sheet.

There are really three main sections of the balance sheet here, and there's actually a formula to all this. In the first box, we have assets equal liabilities plus equity. This is how a balance sheet balances.

Assets equal liabilities plus equity. This is also known as the accounting formula. Let's dive into the nitty gritty of each of these.

I'll give you some examples along the way. With assets, first, we have current assets and we have non-current assets in this section. Now, when you hear me use the term current, all I'm referring to are items that are due and payable within a given year, within a 12-month timeframe.

In other words, these current assets are expected to be collected upon or used up in a 12-month timeframe. The same thing is true when we get down to liabilities. I'll use the term current liabilities.

These are just liabilities that are expected to be settled within that 12-month timeframe. You have current assets and you have non-current assets. According to GAAP, which stands for Generally Accepted Accounting Principles, these accounts are listed in order of liquidity.

That's why on a balance sheet, it's always going to begin with cash because cash is the most liquid asset of a business. That's how they're listed down here, but they're structured current versus non-current, both in the asset section and in the liability section. Let's keep going here.

Under current assets, like I said, we have cash in cash equivalents. That's pretty simple. That's your company's checking or savings account, or if money's invested in CDs or money markets, whatever it may be, but this just represents the true cash of the business.

Next, we have accounts receivable. Accounts receivable is the amount of money customers owe the company. So think about it.

You go out there and you perform work for a business. Now, typically, you're not just going to hand them an invoice and say, okay, I'm done with the work. Can you cut me a check? Instead, especially in the B2B world, you're going to bill them.

So if you're billing your customers, that balance is going to be recorded here in accounts receivable until the money is collected. Underneath accounts receivable, we have inventory. And when a company goes out and buys raw materials or they have work in progress, that's going to be recorded here in inventory.

And then there's also prepaids, which are recorded when a company, let's say they pay their insurance policy up front or in quarterly payments. Well, think about it. If you pay a hundred thousand dollars up front for your general liability or worker's comp insurance on January 1st, that can't just hit the income statement in the month of January.

Otherwise your financials are going to be skewed because you need to match your revenue and expenses in the same period in which they are incurred. So over the year, the company is going to realize the benefit of having this insurance policy. So therefore they need to break out that hundred thousand dollars month by month by month.

So they record it in prepaids and then they release it onto the income statement every single month. And that's how prepaids gets recorded. And then it gets reduced as time goes on.

And then you may have some other current assets up here, but these are the main categories that make up current assets. And then underneath non-current assets, you may have investments in other businesses, but primarily under non-current assets, you're going to have PP&E, which stands for property, plant, and equipment.

So if you go buy a truck or a piece of equipment, or you do tenant improvements to your space, and these assets are expected to provide future benefits to the company, and they have a useful life greater than one year.

And they meet a threshold typically around $2,500 to $5,000 or above, just depending on what the company sets as their capitalization threshold. Then you're going to record this purchase under property, plant, and equipment. You can't go buy a $50,000 truck and just record it on the income statement as an expense.

Instead, you have to record it on the balance sheet, which is called capitalizing that asset. And then you depreciate it over its useful life. So PP&E is going to be the biggest thing typically under non-current assets for a business.

And there may be some other things that are assets of the business that are not expected to mature within that 12-month timeframe. And that would go here in that section. Sometimes non-current assets will also be referred to as long-term assets, right? It just means the same thing.

So those are the assets of a business. And remember, assets equal liabilities plus equity. Let's move down to the liability section.

We have current liabilities and we have non-current liabilities. Now for current liabilities, the biggest thing is going to be accounts payable for most companies. I'm speaking generally here, but think about it.

If your business has accounts set up with trade vendors and you go buy supplies, well, the trade vendor is going to bill your company and give you typically terms like net 30. Well, those balances are going to hit here in accounts payable, and they're going to sit in accounts payable until you pay the bill. So you're going to record the expense on the income statement, but you haven't paid the bill yet.

So that balance is still sitting here in accounts payable. Now you may have some other items underneath here, other accruals like payroll liabilities. For example, you cut payroll for your company, but then you need to submit the federal or the state taxes, but that cash is still sitting in the company because it's not doing payable yet.

That would be recorded in accrued liabilities. So there's some other items down here, or maybe you have a revolving credit card or a line of credit that's doing payable within the 12-month timeframe. You may record that as well in their current liabilities.

Now under non-current liabilities, this is essentially your long-term debt. Now long-term debt needs to be broken out because the current portion of that debt that's doing payable in the given year is going to be recorded up here in current liabilities, but the rest of it is just going to sit in non-current liabilities as long-term debt.

So going back to the truck example, you buy a truck, you finance it, that debt is going to sit down here in non-current liabilities, except for the portion that's due in the current year.

Right? So that's how liabilities are recorded on a balance sheet. And then we have the equity section, which oftentimes can get really confusing for people, but it doesn't have to be. Really, it's just a combination of capital and earnings.

I'm simplifying here. Capital represents the amount of money that flows in from investors who put money into the business. So a company goes out there and they raise capital from investors.

Investors are like, here, here's a million dollars. That inflow is going to be recorded in the equity section under capital. Now, if the company returns that cash to investors through distributions or dividends, it's going to come out of capital and it's going to reduce that capital balance.

That's in the capital section is money in from investors and money out to investors. And then we have earnings, which consists of retained earnings or accumulated earnings of the business over its lifetime and current year net income. So that sits down here in the earnings section.

So essentially equity is the amount of cash investors put in, the amount of cash that is taken out to pay back investors and the earnings of the business. That's the equity section here. So these two liabilities plus equity equal assets.

Now let me just provide a quick illustration to drive home this point even more. When it comes to the balance sheet, the balance sheet is so critical, but it's oftentimes ignored in companies. A lot of businesses that I work with, when I first go into their companies and I evaluate their financial review process, I noticed that they build budgets and forecasts for their income statement, but they completely ignore the balance sheet.

And that can be very dangerous because a lot of cash can be tied up on the balance sheet in inventory or prepaids. Or if you're not managing your accounts receivable, there's just like these hidden monsters that exist on the balance sheet. And that's why it's so important to understand how it works.

So the way that I like to think about it is that the income statement up here, this is the income statement. At the very end of the income statement, we have net income. So all these items flow through the income statement and net income is recorded down here in the balance sheet.

Now for everything else, cash, accounts receivable, prepaids, PP&E, all this stuff. Think about these accounts like buckets. So we have all these buckets on the balance sheet.

Now these buckets include cash, AR for accounts receivable, AP. We have other things, debt. We have all these buckets here.

Let me make this a little bit more colorful. So if you look at a balance sheet, it's always a snapshot of the company's financial position at a given point in time versus an income statement. You could pull an income statement over a period of time, but you're not going to pull a balance sheet over a period of time because it doesn't make sense.

Instead, it's a snapshot at a given point in time of how much the company has in assets, liabilities, and equity. Think about your bank statement, your personal bank statement. If I said, okay, go to your bank account and pull the bank balance between January and December, I mean, it would give you all different types of balances on a daily basis.

And then you would ask me, hey, Steve, do you want to know like the average balance? Do you want to, what are you looking for here? And that's why the balance sheet is always at a certain point in time. It doesn't make sense to pull a balance sheet between January and March. Instead, you just pull a balance sheet as of March 31st, for example, or as of June 30th, right? And then when you take a look at the balance sheet, you're looking into these buckets.

So you put cash into the business and the bucket starts to fill up. And then you collect some more cash from customers. The bucket continues to fill up, but then you have to pay some bills.

So cash shrinks. So the bucket goes down. The same thing is true with accounts receivable.

You send an invoice to a customer and look what happens. Accounts receivable, the balance goes up. And then you send another bill to more customers and it continues to grow, but then your customers pay you.

So accounts receivable goes down and then cash goes up because they're giving you cash and accounts receivable is going down. And that's what's happening on the balance sheet. These balances are changing constantly over time.

Accounts payable is here. Your debt's here. You take on more debt.

You pay down debt. So cash goes down. Your debt goes down as well.

And all of these things are in flux. But when I think about the balance sheet, one thing that helps me is to think about it in terms of buckets and balances versus the income statement. You just have accounts that are recording revenues, expenses, and ultimately profit.

But all of that just flows down here and then this bucket fills up. And same thing down here with equity. If I have my equity bucket, I get capital coming into the business.

I have earnings of the business and it goes up. When I experience losses, those losses come down. And then these other accounts make up for those losses.

Cash may go down and all these buckets are constantly in flux. But if you just remember, a balance sheet is organized like this: Assets = Liabilities + Equity, and you understand what accounts hit the balance sheet, you're going to be so much more confident when it comes to reading financial statements and understanding the story behind the numbers.

Let me ask you this. What questions do you have on the top of your mind? Will you drop those down below in the comments box?

Because I'll read these comments and I'll know what content to make in the future to drive even greater value to you.

But I want you to be confident with your numbers because when you understand what's on the income statement, what's on the balance sheet, and what's on the statement of cash flows, and you understand the story behind the numbers, then you're going to be empowered to drive greater value within your organization.

All right. Thanks for joining me for this episode.

And until next time, take care of yourself. Cheers.