14. Mini-Series: Demystifying Your Financial Statements - Balance Sheet

Bookkeeping

Oct 30

0:11: Welcome back to the accounting edit.
0:13: I'm Amander Mann from Sequoia CPA and I'm Lee McCool with Oca Accounting.
0:19: So today we're focusing on the 2nd episode of our miniseries about demystifying your financial statements and we're focusing on the balance sheet.
0:29: So really by the end of this episode, you'll not only know what a balance sheet is, but you'll know how to use it and how to make informed decisions from it.
0:37: So just to kick off, Leah, what is a balance sheet?
0:40: OK, so a balance sheet is one of the main financial statements that all businesses use and just to provide a definition in Real English.
0:51: It's a snapshot in time of what your business owns, what it owes, and what's left over.
0:57: And it's all listed in one place.
1:00: And so a simple formula to remember this by and just how your balance sheet is organized is assets, equals, liabilities, plus equity.
1:10: So this will kind of, as we go forward, there are so many different ways to really read the data within this statement, but we'll dive into ratios and all of that at a later episode, but this is really just covering, here's what's within this, this financial statement and what to pay attention to.
1:30: Perfect.
1:31: And then just kind of breaking down the sections, I think it'll help to kind of Understand what is an asset.
1:37: So an asset is really the cash, accounts receivable, inventory, any fixed assets you have on there.
1:44: So the way you want to think about it, your business's toolbox.
1:47: So this is everything you use to make money as well.
1:51: So cash is really the liquid part of your assets, but really everything else is tools that you can use, like equipment or inventory you're selling, these are all the assets that are listed on your balance sheet and they're listed first on the balance sheet.
2:06: So when you're reviewing it, you'll look at this and it'll be the top section.
2:10: So that's where the assets live.
2:11: And right after that is the liabilities and so this is really everything in your business that you owe to someone else.
2:18: So this can be things like credit cards, line of credit, any sort of long term loans that can be listed here.
2:26: So all those amounts will be listed in the second section.
2:30: And again, this will be totaled and it's right after the assets.
2:34: So the last section on your balance sheet is actually equity.
2:37: So this is listed last and basically this is what's left over for you as the business owner after you've paid everything off.
2:45: So really it represents your ownership in the business or you could think of it as your business's net worth.
2:52: And so within equity, you'll see a number of different accounts listed such as owner contributions and this is money that you put into your business to fund your business.
3:02: There's owner draws or distributions, which is money you take out to pay yourself, and then there's also retained earnings and this is the profits that your business has produced over time.
3:13: And so when you look at the equity section.
3:16: You're really seeing your investment plus all the profits your business has built up over time and so it really shows your true ownership value.
3:25: And so Leah, help us kind of walk through why does this matter?
3:29: Why would a business owner really want to look at their balance sheet and why is it important to them?
3:33: Yeah, so comparing it to the income statement and the profit and loss in our last mini-series episode demystifying the profit and loss, we give that description of this is giving what has happened in a specific period of time, and it's limited to that period of time.
3:53: With the balance sheet.
3:55: You have to understand that it's a snapshot, but what that means is that every balance, everything that has happened into your business and it has accumulated up until that date.
4:07: And so, for example, your cash balance is saying everything in your business has led your business to have this amount of cash in this moment of time.
4:17: And same thing with loans.
4:19: If you have opened a credit card account at the beginning of the year and say you racked up a huge balance, you will not see that huge balance.
4:28: Of January's balance sheet in November because you will likely have made payments to that credit card balance and have paid it down.
4:38: So the actual amount owed is much lower than what it would look like in January.
4:43: So that's what we mean when it says it's a snapshot.
4:45: It is everything that has happened in your business up to that point in time, and it reflects that.
4:52: So why it matters is because this all helps you see your true financial health of your business, not just how you're performing in a specific period of time.
5:02: It shows lenders and investors or any sort of third party your stability.
5:08: And for example, if you have a huge amount of debt, then hopefully you'll be able to give context to what that debt is doing for your business.
5:18: Maybe it is in the long term going to produce more revenue, but in the short term, it means that you maybe have a huge balance of debt that's on your books that might be concerning without that context.
5:32: And It tracks how your business is growing over time.
5:37: I mean I mentioned retained earnings.
5:39: So if that is going up, then that's a great sign.
5:42: If it's going down, then that means that your business is losing money and is maybe not so great, or it's all of those numbers that should hopefully provide context to how you're performing.
5:54: But over years or over the entire lifespan of your business.
5:59: And this really, it connects to the other reports, it works with your profit and loss and cash flow statement, and it really just serves as that, that snapshot of, here's everything that your business owns.
6:15: And what is all left over because the profit and loss and cash flow show deeper into what is happening in the actual performance basis, but then also the cash movements of what is happening within your assets.
6:29: so that is really how I would say on a high level, this is how it matters and how business owners should consider it.
6:37: Perfect.
6:38: Yeah, and I think that's a really good clear outline, Leah, on the different reasons why business owners should be looking at this and I know you mentioned some of the ratios and so I, that's where it comes into play is really understanding the relationship between the Different accounts even on the balance sheet.
6:56: So comparing liabilities to assets and we'll go into this in another episode but not only the ratios between different accounts on the balance sheet but also the relationship to the other statements I think is really important to understand how does your Net profit on your P&L flow into your retained earnings.
7:14: And so there's a really good call out that it's not, you're not just looking at one statement, it's the relation also with all three of them when you're reviewing at month end.
7:23: 100%.
7:24: Yeah, and so some of the common mistakes we do see on the balance sheet, number one is forgetting to reconcile accounts, so your numbers are wrong.
7:32: So what does reconcile reconciling your accounts mean?
7:36: It means to check the balance.
7:38: Again another source document.
7:41: So in case of your bank accounts, you want to use your bank statements and use those ending balances and tie to your cash balance is on your balance sheet.
7:49: So it's important to do that, otherwise you don't know if the balances that live in your software actually tie to reality.
7:57: So if you're forgetting to do this, you don't know if that data is accurate.
8:01: So it's really important not only just asset accounts, but look at your liabilities, look at your equity accounts and tie them out and ensure that they're correct.
8:09: Another mistake is really not separating personal and business.
8:13: When you co-mingle a lot of this data, it can live on the wrong accounts on your balance sheet and this can cause confusion in terms of is this actually business, is this not business, can throw off your balances and so you don't get a clear, accurate picture of your business.
8:29: So it's really important to separate personal and business assets and liabilities so they're not On the books.
8:35: And then also ignoring retained earnings.
8:37: You want to be able to tie out your retained earnings with what your business has generated in terms of profit through your business year to date and then you should also have, if you're having owners draw, you need to be able to classify it as a draw from your business and not in any other category.
8:53: So you need to be tracking how much money are you pulling out from your business and it should be classified under equity under what's considered an owner's draw or a distribution depending On the type of business setup you have.
9:04: Another one is really just not looking at undeposited funds.
9:07: So I see this a lot because a lot of Stripe accounts get connected or you have honeybooks that's connected.
9:14: It puts amounts to something called an undeposited funds and so you really need to reconcile and make sure that zeros out at the end of the year or at the end of the month to ensure that you're receiving all that money.
9:26: So you're tying out, yes, I received the funds and tying it to your bank.
9:30: Account and not double booking it against revenue.
9:33: So it's really important to look at undeposited funds.
9:35: If you haven't received the funds, you should follow through and figure out why you haven't received them and clear that out.
9:42: So these are kind of the common mistakes we generally tend to see on the balance sheet.
9:47: I'm sure there's a lot more that we can dig deep into Lea as bookkeepers, we come across a lot of this data.
9:54: these are some of the common highlights.
9:56: Absolutely.
9:56: This is a difficult Statement, I think it's a lot less intuitive than a profit and loss and maybe not in when you actually break it down and have someone explain it to you or you take an accounting course or you have your accountant kind of cover what is happening here, but it's definitely not as intuitive to think of things in terms of assets, liabilities and equities.
10:18: We want to make sure that people understand that it's awareness and knowing where you stand, that's going to allow you to make better decisions.
10:25: So if you take really one thing away, I guess from today's episode, it should be that your balance sheet isn't just a report like you mentioned for an accountant to look at.
10:35: It is a little bit more nuanced than a P&L because it's not talked about as much, but it's a tool for all business owners to use and to check on their financial health.
10:45: So you want to be able to use it to look at your business at the end of the day.
10:49: And see how you're doing.
10:50: So really as a business owner, you should be asking yourself, do I have enough cash to cover the next few months, right?
10:56: Am I taking on too much debt like you mentioned?
10:58: So it's really about looking at your business building value over time.
11:02: So I think it's really important to do these small check-ins on a monthly basis so you can really understand how your business is changing and how you can manage it better.
11:11: Absolutely.
11:11: And I think Just having these check-ins with yourself, if you are doing your books yourself, it can really just change how you view your business and manage your business holistically beyond just your profit and loss.
11:26: And so, if you are in a place where you're kind of lost when looking at this report or you're wanting support and just understanding your own numbers, how to read this, both Amander and I work with small business owners just like you.
11:39: that's definitely something that we love to do.
11:42: Because we just have a passion for all things accounting.
11:46: And so we are here to be a resource and you can find both of us at our own websites where we help clients in a variety of ways.
11:56: And so, definitely, we would love to chat with you if you are needing help.
12:00: So, you can check the links, like I said below in the description of this podcast, and we would love to chat with you.
12:07: So thank you all for listening and we will see you next time.
12:15: You've been listening to the Accounting Edit, a podcast by Amander Man of Sequoia CPA and Leah McCool of Orca Accounting.
12:23: And if you're enjoying the show, don't forget to follow us so you don't miss an episode.
12:28: And if you have any feedback or thoughts, we'd love it if you left us a review.
12:32: It really helps us out and we'd love to hear what you think.
12:35: Does your business need help on the accounting side of things?
12:37: We would love to help you.
12:39: You can find Amander at sequoia.
12:41: CPA.com or on Instagram at Sequoia CPA.
12:46: You can find me, Leah at Orca-counting.com or on Instagram at Orcacounting.
12:54: We'll be posting new episodes every other week, so be sure to follow so you don't miss out.

Summary

In this episode, Aminder Mann and Leah McCool delve into the intricacies of the balance sheet, a fundamental financial statement for businesses. They explain its components, including assets, liabilities, and equity, and emphasize the importance of understanding how these elements reflect a business's financial health. The hosts also discuss common mistakes made in balance sheet management and provide insights on how to effectively use the balance sheet for informed business decisions.

Takeaways

• A balance sheet is a snapshot of a business's financial position.

• Assets equal liabilities plus equity.

• Understanding the balance sheet helps in assessing financial health.

• Common mistakes include not reconciling accounts and mixing personal with business finances.

• Retained earnings reflect the profits generated over time.

• The balance sheet connects with other financial statements.

• Regularly reviewing the balance sheet aids in better decision-making.

• Business owners should check their financial health monthly.

• The balance sheet is a tool for all business owners, not just accountants.

• Understanding the balance sheet can change how you manage your business.

Key Words: balance sheet, financial statements, assets, liabilities, equity, accounting, business health, common mistakes, financial management, decision making, bookkeeping