Recently we looked at a new client’s balance sheet and saw that there were way too many accounts that gave rise to issues based on our understanding about his company. We realized that he perhaps didn’t fully appreciate the importance of his balance sheet and how to read it.
It is crucial as a business owner or someone preparing a report for the company’s management, that you comprehend what the numbers on the balance sheet are revealing.
Thanks goes to Cynthia Huber at The Marks Group PC for this primer –
Assets are the first section on the balance sheet. Your current assets are listed first. Current assets are cash or cash equivalents that can be expected to be converted to cash within a year.
Your bank accounts are listed first and the normal balance will be a debit. If any of your bank accounts show a credit balance, that account is overdrawn as of the date of the balance sheet.
Accounts receivable will be the next current assets on your balance sheet. This account will have a debit balance.
The next group of current assets will depend on your type of business. They may be customer deposits, prepaid expenses, inventory, employee advances, etc. They should all have a debit balance and you can convert them into cash within a year.
The last group of assets will be your fixed assets. These cannot be converted to cash within a year. They will consist of your property, furniture and fixtures, equipment, automobiles, etc. These accounts will have a debit balance. There will be an accumulated depreciation account associated with these accounts that will have a credit balance.
If you have paid any security deposits it may be listed under Other Assets on the Balance Sheet.
Your liabilities are what you owe to others. A current liability will be paid off within a year.
Your current liabilities will be accounts payable, and all your credit card accounts. These accounts should have a credit balance. If an account has a debit balance you may want to investigate the reason. For example, a credit card account may show a debit balance which would indicate that you have a credit due to you from them.
If you have employees, your other current liabilities will be payroll liabilities. Depending on the number of employees and the benefits you offer your employees, you may have several liabilities, or you may have just the payroll tax liabilities. Whatever liabilities you have, they should have a credit balance. If a liability has a debit balance, then you have probably over paid and are due a refund.
Your long term liabilities are the debts that will not be paid off within a year. They will be your mortgage payment, loan payments, vehicle payments, etc. These liabilities will also have a credit balance.
This is the last section of your balance sheet and it shows how much money has been invested in your company. Depending on the type of entity, you may have an Owner’s Equity account, Capital Stock, or Treasury Stock account.
Your retained earnings account shows what your company has earned since the beginning of it’s operation. Your retained earnings should be a credit if your company has been making money. If your company has not been making money it will be a debit balance.
Dividends paid to shareholders, and draws to owners and partners will have a credit balance.
The balance sheet is a snap shot of your company’s financial position at a single point in time. The purpose is to give the users an idea of the company’s financial position along with what it owns and owes.
It is very important that you understand how to analyze and read this document.