Once all the data is in the accounting ledgers, now comes the best part, reporting results to the owners and management team.
The balance sheet serves as an historical report. It identifies the accumulated change in value since inception. The balance sheet is organized into two halves and both sides must be equal in value. In addition, the balance sheet is a snapshot of the financial condition at a single moment in time along the lifetime timeline of the company.
The most common dates used for the balance sheet are the year-end or end of the accounting cycle. Thus, if a company were in business for 60 years and the accounting cycle is annually, there will be a total of 61 balance sheets. Notice there is one extra and this is because there is always a beginning with zero assets and equity (some will start with the initial contribution at the end of day 1 of the company). Most small businesses have 12 monthly cycles aggregating into an annual cycle. Large publicly traded companies have four quarterly cycles culminating in an annual report.
As the bookkeeper it is your job to prepare and print the balance sheet. With larger companies this function is carried out by the head or senior accountant. In business operations with more than $5 Million in revenue, a controller or finance manager completes this step.
To do this, you need to understand how a balance sheet is organized, formatted and how it is analyzed.
Balance Sheet Organization
The balance sheet organization is straight forward. Two halves, the upper half presents existing assets and the lower half identifies the sources of capital (liabilities and equity) used to purchase or acquire the assets.
Each half is organized based on liquidity. Assets are organized by the ability to liquefy (turn it into cash) the particular asset. Liabilities and equity are prioritized in order of necessity to pay (most current to the least). A typical summary format for a balance sheet is as follows:
Upper Half – Assets
Lower Half – Liabilities and Equity
In general equity comprises two fundamental sources. The first is the original capital invested and the second refers to historical earnings net of payments to owners. It is last in the hierarchy of payment, i.e. the investors assume the ultimate risk of getting their money back and receiving the historical earnings.
Within each of the groups, the concept is the same. They too are organized by liquidity or demand for payment. Let’s look a the two most detailed.
Current assets are the primary group of assets as they are the most liquid. Cash already exists in a liquid state, inventory can easily be turned into cash by selling the product. Accounts receivable can be turned into cash via collections and prepaid expenses represents cash spent to purchase a future value. The most common prepaid expense is insurance.
Charge Accounts (Credit Cards)
Accrued Expenses (Payroll)
Lines of Credit
Current liabilities are prioritized in order of those requiring immediate attention to those with lesser demand. Accounts payable are typically the first as most vendors only allow for a maximum of 30 days to pay their respective invoices. Credit cards are more lenient even though they too are 30 days. The difference is that credit cards use a revolving feature which means the company can ignore the balance and simply pay a minimum payment. Accrued expenses are customarily in the form of taxes for payroll and income purposes. Here the government entities involved want the accounts cleared quarterly. There is a demand cycle that gets extended the further down the line-up in this group.
Organization of a balance sheet is by halves, then by major groups and finally by liquidity or demand within that group. To properly present a balance sheet, the bookkeeper needs to understand the format.
Format of the Balance Sheet
There are several acceptable formats for a balance sheet, but this lesson is only going to explain the most basic format. The format requires a proper header, columned values and balance.
The header is three lines of information centered on the page. The first line is the legal name of the business. Do not use the trading name or other forms of identification such as the D.B.A.
The second line is the title of the report, in this case ‘Balance Sheet’. In other lessons I explain about variations of the balance sheet (comparative, divisional and limited scope).
The final line is the date. It is important to pay attention to the date as often bookkeepers with a lack of experience will print balance sheets with a different date than the corresponding income statement (profit and loss statement).
When you look at the balance sheet the primary column states the respective half, groups and subgroups (based on liquidity or demand for payment). The final column typically totals all group values for the respective half. In this final column the respective values for the major groups are included. The column next to the group/subgroup identifier merely expresses the values associated with the subgroups. Take a look:
December 31, 201X
Accounts Receivable Z,ZZZ
Prepaid Expenses ZZZ
Sub-Total Current Assets $ZZ,ZZZ
Accumulated Depreciation (ZZ,ZZZ)
Sub-Total Fixed Assets ZZ,ZZZ
Organizational (Net) ZZZ
Land Held for Future Use ZZ,ZZZ
Sub-Total Other Assets ZZ,ZZZ
Total Assets $ZZ,ZZZ
Accounts Payable $Z,ZZZ
Charge Accounts ZZZ
Accrued Expenses Z,ZZZ
Line of Credit Z,ZZZ
Sub-Total Current Liabilities $ZZ,ZZZ
Mortgage Note ZZ,ZZZ
Vehicle Note Z,ZZZ
Sub-Total Long-Term Debt ZZ,ZZZ
Total Liabilities $ZZ,ZZZ
Common Stock ZZ,ZZZ
Retained Earnings ZZ,ZZZ
Total Equity ZZ,ZZZ
Total Liabilities and Equity (should match assets) $ZZ,ZZZ
Notice in the equity section that there are no formal major groups? Although equity has groups, they rarely exist in the small business presentation. Therefore, the format skips group identification and simply identifies the significant lines of data. Although there is a substitute of Z’s for numbers, the two halves (Assets and the bottom half of Liabilities and Equity) will equal each other in value.
This is critical to understand. The balance sheet must be in balance. This report is the final result of all the initial entries into the journals, transfer to ledgers and a result of a well organized account structure via the chart of accounts. If there isn’t balance with both halves, somewhere there exists an error.
Modern technology has pretty much eliminated the ability to enter or post an unbalanced (dual entry) journal entry. Thus, it is nearly impossible to generate an unbalanced report. But it can still happen and this is why it is important for the bookkeeper to be mindful of the underlying systems.
Balance Sheet Analysis
It is rare for the bookkeeper to analyze the balance sheet; this is generally a task assigned to the chief financial officer. Others that review this include the Certified Public Accountant (CPA), the corporate president, or the board of directors for the company. But this lesson introduces you to some basic analysis so you can feel comfortable and satisfied with your work.
The following are some basics:
The first and most important is the cash position of the company. Look at the total cash value of the business; does it make sense? Is it higher than normal and if so, why? Learn what is a normal cash position for a company. If the cash position is higher, was there a recent significant payment from a customer? What about a low balance; was there a recent expenditure that consumed a large amount of funds?
Cash is absolutely the most important asset in any business. Always focus on cash first, know what is normal and why the balance is not currently normal.
One of the most common reasons businesses become insolvent is the inability to collect money from their customers. If the receivables grow from one period to the next, is this growth a reflection of an increase in sales or lack of ability to collect the money?
Vendors and suppliers get upset when there is no or slow payment to them. Again, this is a function of cash. Management should decide who gets priority for payment, NOT you. Rest assure, no matter who you decide to pay first, management will find fault.
If payables are increasing, then sales had better be booming. Otherwise this is an indication of cash flow issues. Every enterprise’s goal should be to pay all bills within a week of receipt.
Fixed Assets and Debt
Most small businesses finance fixed assets by using debt (long-term notes). Whenever long-term debt exceeds the fixed asset value there could be future trouble. Most debt instruments are structured and amortized to match the decreasing value of the corresponding fixed asset. Often management depreciates the fixed assets using accelerated depreciation. Therefore, the fixed assets section has a lower value than long-term debt.
As the bookkeeper you need to recognize the form of depreciation used and evaluate the relationship between fixed assets and long-term debt. Depreciation is taught as an advanced skill with this bookkeeping series (Volume 2).
The best situation is to have equity greater than total liabilities. This means the business is well funded. Within the equity section make sure current earnings match the profit or loss reported on the income statement (profit and loss statement). If not, it is typically a date correlation issue; i.e. the time period of the income statement’s last date doesn’t match the date of the balance sheet.
Proper balance sheet presentation requires good organization, proper format (header, columned values and balance) and confirmation of information presented; is it normal and does it make sense? ACT ON KNOWLEDGE.
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