Reading your balance sheet and profit and loss account
Written by Ilias Aarrass6 min read · Published on · Last reviewed on 
In short
The balance sheet shows at one moment what you own and still owe, the profit and loss account shows across a year what you earned; together they explain why profit is not cash.
- As an entrepreneur for income tax you calculate your taxable profit from your business's profit and loss account and balance sheet.
- Equity rises through profit and private deposits and falls through private withdrawals; if it falls while you make a profit, you are withdrawing too much.
- The VAT and income tax you still owe sit on your balance sheet as debts: that money is in your account but is not yours.
- At the year-end close you check four items: your bank balance, your receivables, your VAT liability and your stock.
Every year your bookkeeper or your software hands you two statements, and many entrepreneurs scroll straight to the number at the bottom. A shame, because those two pages tell you exactly where your business stands. The idea behind them is simpler than the terminology suggests: the balance sheet is a photo of one moment showing what you own and still owe, the profit and loss account is a film across a whole year showing what you earned. In this article you read them from left to right and top to bottom, with the five figures to watch monthly.
The balance sheet: assets left, funding right
A balance sheet has two sides that are always equal. On the left (assets) is what your business has: your equipment, stock, what clients still owe you and the money in your business account. On the right (liabilities) is how that was funded: your equity, plus debts such as suppliers still to be paid, VAT still to be remitted and any loan. Both sides are equal by definition, since everything you have was paid for somehow.
Equity is the most interesting figure on the balance sheet: it is what remains once all debts are settled. In a sole trader business it moves through three things: profit raises it, your private withdrawals lower it and a private deposit raises it again. If profit grows while equity falls, you are withdrawing more than you earn. That is not a bookkeeping detail but a warning.
The profit and loss account: from revenue to profit
The profit and loss account runs top to bottom. At the top is your revenue, excluding VAT. Below it the direct costs or cost of sales: materials, bought-in hours, goods. What remains is your gross margin. Then come the fixed costs you incur regardless: insurance, software, phone, your workspace, vehicle costs and accounting fees. Finally depreciation on your assets, and then you reach profit.
Note that this profit is not yet your income. In a sole trader business the entrepreneur deductions come after it, such as the self-employed deduction and the SME profit exemption, and only then is tax calculated. And two items in your profit neither cost nor bring in money that year: depreciation is a past outlay recognised now, and an invoice sent in December counts as revenue even if the client pays in February.
Why profit is not cash
This is the key lesson from both statements together. You can post a fine profit and still be unable to pay your VAT, because the money is sitting with your clients. Conversely a healthy balance can mislead when an assessment is still coming. If you want to watch one thing weekly, do not pick profit but your receivables and your tax pot.
Five figures to check monthly
You need no analysis to put your figures to work. Five numbers, once a month set against last month's, tell you nearly everything. This fits neatly into your monthly routine. To see where those numbers come from, look at your chart of accounts.
- Revenue per month, compared with the same month last year rather than with last month.
- Gross margin as a percentage: if it slips, your purchase costs are rising faster than your rates.
- Fixed costs per month: the amount you must turn over just to break even.
- Outstanding receivables and the oldest invoice among them; anything over sixty days needs action.
- Your tax reserve: is there enough set aside for this quarter's VAT and for income tax?
What to check at year-end
At year-end the balance sheet is your control tool. Check four items. Does the bank balance on it equal your final statement of 31 December? Do receivables match the invoices still open on 1 January? Is your VAT liability equal to what you actually remitted in January, or does it need a correction return? And is your stock counted and valued on the balance sheet rather than estimated?
If those four add up, the rest very likely does too and your return is a formality. If they diverge, there is nearly always a forgotten receipt, a double-posted invoice or a private withdrawal booked as a cost behind it. That is exactly the kind of difference an audit spots first.
What sits where
The two statements answer different questions. Once you know which figure belongs where, you can see how your business stands in a minute.
| Balance sheet | Income statement | |
|---|---|---|
| What it shows | What you own and what you still owe | What you earned and spent |
| Which moment | One reference date, usually 31 December | A whole period, usually a year |
| Where your bank sits | On the left, with your assets | Not in this statement |
| Where your turnover sits | Not in this statement | At the top, as the first line |
| Where an investment sits | On the left, depreciated annually | Only this year's depreciation |
| Why profit is not cash | Unpaid invoices sit here as receivables | The turnover counted when you sent the invoice |
Frequently asked questions
Must a sole trader draw up a balance sheet?
Yes. In your income tax return you complete a tax balance sheet and a profit and loss account, even without staff. Publishing is not required, that applies only to companies. See annual accounts for freelancers.
Why is my profit higher than what is in my account?
Usually three causes at once: unpaid invoices that still count as revenue, private withdrawals that are not costs, and a tax liability not yet settled. Set your balance sheet against your bank statement and all three surface quickly.
What is healthy equity for a freelancer?
A common rule of thumb is three to six months of fixed costs, business and private combined. More important than the exact amount is the direction: equity falling year on year while you make a profit means you withdraw too much. See building a buffer.
Do I need a bookkeeper for this?
Not for reading them, often yes for drawing them up: tax depreciation, provisions and reconciling with your return are precise work. The combination works best, see doing your own books or outsourcing.
Sources
- Profit and loss account and balance sheetBelastingdienst · belastingdienst.nl
Sources checked on
This article provides general information based on the rules known for 2026 and does not replace personal tax advice. For your specific situation, we're happy to take a look with you.
