Balance Sheet Basics Part 1: What Is The Balance Sheet?

balance sheetA lot of business owners (and even many bookkeepers) really don’t understand the Balance Sheet.  They are mostly concerned with the Profit & Loss report and the only Balance Sheet item they care about is the checking account.  I find this to be a huge mistake on their part!  In my opinion, the Balance Sheet is even more important than the P+L and it’s a real shame that people totally neglect it.

Today’s article is the first in a series titled “Balance Sheet Basics”.  Throughout this series I’m going to state my case as to why the Balance Sheet is important and maybe I’ll be able to convince you that it’s even more important than the P+L!

First off, let me define exactly what the Balance Sheet is.  It is a financial report that presents all of a company’s assets, liabilities and equity accounts as of a certain date.  It is often referred to as a “snapshot” of the company’s financial position since it does only provide the balances as of one particular point in time (unlike the Profit + Loss report which covers activity for a range of dates).

There are three main sections of any Balance Sheet, Assets, Liabilities, and Equity.  The total of the asset section minus the total of the liabilities equals the total of the Equity section (that’s the “balance” part of “Balance Sheet”).  Just to repeat that one more time:

ASSETS – LIABILITIES = EQUITY

This equation is one of the fundamental concepts that you must know in order to work in accounting.  It should just be second nature to you to understand how this works.  Even though most of your work will be on the computer and it will take care of the balancing for you, it will help you immensely if you know and understand this concept.

To put it in a simple example, let’s say that ABC Company owns a building that cost $700,000 and that is the only asset that it has on the books.  It also has a mortgage with a balance of $250,000 at the end of the year.  We are ignoring a lot of other details for this example, but for the sake of this lesson, let’s assume that there are no other account balances at all.  Using the accounting equation we can calculate that ABC Company has equity of $450,000.

$700,000 – $250,000 = $450,000

Each main section of the Balance Sheet is further divided into “sub-sections”.  Some of the most commonly used ones are listed below.  I will cover each of these in more detail in the future since they all deserve their own write up.

Assets

  • Current Assets:  Assets that are expected to be sold or used up within the next 12 months such as cash, inventory and accounts receivable
  • Fixed Assets:  Tangible assets that are expected to last for more than one year such as equipment, land and furniture
  • Intangible Assets:  Non-monetary assets that cannot be physically touched such as patents, copyrights and trademarks

Liabilities

  • Current Liabilities:  Debts and obligations expected to be paid off within the next 12 months such as accounts payable
  • Long-Term Liabilities:  Debts and obligations not expected to be paid off within the next year such as a 30-year mortgage

Equity

  • The Equity section doesn’t really have any “sub-sections”.  It just has accounts like Common Stock and Retained Earnings

Within each of these sub-sections are the individual account balances.  For example the Current Liabilities section might contain three line items: Accounts Payable, Accrued Payroll and Sales Tax Payable.  Some of the accounts presented on the Balance Sheet may represent several accounts on the company’s Trial Balance.  For example, the Company might have 3 accounts on the Trial Balance for various accrued expenses such as Accrued Payroll, Accrued Payroll Taxes and Retirement Plan Contribution Payable.  These three individual accounts balances may be grouped together into one single line item on the Balance Sheet called “Accrued Expenses”.  This makes for a cleaner, more compact presentation and is acceptable as long as the groupings make logical sense.

The Equity section of the Balance Sheet contains accounts that deal with ownership of the company and how much capital has been invested.  Some common accounts are:  common stock, preferred stock, treasury stock, additional paid-in capital, shareholder distributions and retained earnings.

Here is a sample Balance Sheet from QuickBooks for you to review (click the image to view a PDF):

sample balance sheet

I have much, much more to say about the Balance Sheet but this post has already gone on far too long!  If you have any questions or comments, please leave them in the comments section below.

This post was written by Michael Debyah.

Update Your Skills

bookkeeping ledgerTake your accounting and bookkeeping skills into the 21st century!  If it’s been a while since you learned anything new in the world of accounting, now is the perfect time to enhance your existing skill set.

Maybe you worked as a bookkeeper years ago before you had kids and now it’s time for you to get back into the workforce.  Or maybe you were recently laid off and are looking for a new job and want to add some new skills to your repertoire.

Even though the economy is not doing so well right now, accounting and bookkeeping professionals are still in demand.  Businesses still need their books to be done even if they aren’t making as much money as they used to.  And many businesses owners are looking to analyze their bottom lines much more closely than in the past, so they want to make sure that the books are correct.

If you take a quick look through the want ads in your local paper chances are pretty good that you’ll see some openings for bookkeepers and accountants.  Many of these ads will list what the job responsibilities are and will include things like “general ledger” or “full charge bookkeeper” and “quickbooks experience necessary”.  Many of the job listings in my paper list QuickBooks as one of the requirements.  The lessons that I teach here will help you qualify for one of these jobs.

I am currently teaching a QuickBooks training class at night and 3 out of the 4 people are all looking for bookkeeping jobs.  One person is re-entering the workforce after having kids and being out of the game for 6 or 7 years, one person was recently laid off and had been using another very specialized bookkeeping system and the third person just moved to the U.S. and isn’t familiar with QuickBooks but knows other European-based software packages.

So no matter what your reason for wanting to learn, I welcome you and look forward to interacting with you here.  Good luck in your journey and please let me know if you have any questions, comments or special requests for lessons.

This post was written by Michael Debyah.

Basic Financial Statements

financial statementsAt some point, every business will need a set of financial statements.  Maybe you need to obtain a loan from the bank and they want to see a set of statements prepared by your accountant or you need them to give to a new investor.  Most people don’t know what “financial statements” are, so let’s take a look.

The most common set of financial statements include a Balance Sheet, Income Statement and Statement of Cash Flow.  The statements will include a report written and signed by the accountants (more on this later) and may include footnotes (these are optional).

The Balance Sheet shows the company’s assets, liabilities and equity.  Assets are things that the company owns, like bank accounts, equipment and inventory.  Liabilities are what the company owes to others, such as bank loans and credit card balances.  The Equity section shows how much stock or capital has been put into the company and is what makes the Balance Sheet balance.

The Income Statement shows the company’s revenue or sales and subtracts out the Cost Of Goods Sold (if applicable) and all of the other expenses.  The result is the Net Income (or loss).  It’s usually the last number on the income statement, which is where the phrase “the bottom line” comes from.  This is the report that most business people care about the most because it shows how much money the company has made (or lost).

The Statement of Cash Flow is a report that shows the sources and uses of cash.  If the other two statements are prepared on the accrual basis, this report converts the information to the cash basis so it becomes more apparent what areas of the business produced or used the most cash.  It is the most difficult statement for people to understand, and it requires it’s own long-winded explanation.  I’ll cover it in more detail in a later post.

Remember that signed report from the accountant that I mentioned earlier?  That’s the most important part of the whole set of financial statements.  The business owner can produce their own set of financial statements, but the bank (or whoever else needs the statements) usually wants them to be prepared by a third party.  This in theory makes the statements more reliable since the business owner could easily create misleading statements since they aren’t checked over by anyone else.

There are 3 different levels of service that an accounting firm can provide for financial statements.  A compilation provides the lowest level of assurance on the statements.  This means that the accountant takes account balances and figures that the management of the business gives them and they put them in proper financial statement format without auditing or examining them in any way.  If something looks obviously out of sorts, the accountants will question it, but with a compilation the accounting firm assumes almost no responsibility for the accuracy of the information.

The next step up is a set of reviewed financial statements.  This is basically just like a compilation but the accountants ask a lot of questions, compare the account balances from one year to the next and “poke around” to see if anything sticks out as a problem.  The accountant’s report in this case will state something like “On the basis of our review, we are not aware of any material modifications that should be made to the accompanying financial statements in order for them to be in conformity with generally accepted accounting principles”.  This type of report provides limited assurance as to the accuracy of the financial information.

The highest level of assurance is obtained by audited financial statements.  This is a very involved process where the accounting firm determines areas of risk, test the company’s internal controls, asks a lot of questions and examines account balances in much more detail.  It is the most expensive option, but at the end of it all the accounting firm will issue a report that states that the financial statements are in conformity with GAAP standards.

So there you have it!  I hope that you find this information useful and that you now understand what financial statements are a little bit better.  Please leave a comment below if you have any questions or what to say anything at all about this post or the site in general.  There is much more to come!

This post was written by Michael Debyah.