Significance of the Balance Sheet

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About this lesson

Understanding this report will help users identify errors and generally see the health of a business, regardless of it's size.

Quick reference

Significance of the Balance Sheet

The balance sheet gives a snapshot of the company’s finances at a specific point in time. It comprises assets, liabilities, and equity.

The Purpose of the Balance Sheet

  • Awareness: The balance sheet helps in understanding the cash and debt
  • Error Checking: It is a tool for spotting mistakes. Discrepancies in account balances, such as bank balances that seem unusually high or low, can indicate errors elsewhere in the accounts

Common Red Flags

  • Incorrect Balances: Review each account to ensure the balance matches your records
  • Erroneous Account Names: Ensure that expense accounts are not mistakenly listed as assets

Assets

This is a listing of the cash, anticipated cash (receivables and inventory), and equipment that the business owns. It’s important to review this and ensure that the assets are up to date as there is not always a bank or loan statement to compare the records against.

Liabilities & Payables

Understand that liabilities represent the debts of the business, which can include loans, payroll taxes, and sales tax owed. These should be carefully reviewed to ensure that the business is not underestimating its debt.

Equity

Equity can be complex, representing the owner’s stake in the company. While it may include both positive and negative numbers, getting accustomed to this part of the balance sheet can take time and often has company-specific nuances. 

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  • 00:04 The significance of the balance sheet.
  • 00:06 When asked why a business owner should look at a balance sheet,
  • 00:10 the answers are really general awareness.
  • 00:14 Just knowing how much cash and how much debt a business has is incredibly helpful.
  • 00:19 Another really good reason is to look for errors.
  • 00:22 If a bank balance is really high or really low, that means that a different
  • 00:27 account is definitely impacted and definitely incorrect.
  • 00:32 Sometimes the easiest place to find mistakes is in the balance sheet,
  • 00:36 when looking at the account balances.
  • 00:39 I'm going to specifically address two red flags to watch for.
  • 00:43 The first is when the balances simply aren't correct,
  • 00:46 that could be checking credit card, loan, you name it.
  • 00:50 And the second is when there's duplicate or erroneous account names.
  • 00:55 I know that sounds funny, but every so often I'll run across a client
  • 00:59 that accidentally adds their credit card twice and all the related charges.
  • 01:04 So the balance is correct, it's just in there two times.
  • 01:09 Erroneous account names could be something such as Office Supply Bank.
  • 01:15 Well, the office supplies are an expense.
  • 01:19 So if they show up on the balance sheet as if they were a bank account,
  • 01:22 then that's a problem because it's not being tracked with the expenses.
  • 01:27 Let me demonstrate this using accounting software.
  • 01:30 The first software I'm going to use is QuickBooks Online.
  • 01:33 I'm going to start by selecting Reports on the left-hand side of my screen.
  • 01:37 I will then select Balance Sheet in the upper left-hand corner.
  • 01:40 What you're viewing is the balance sheet for the business.
  • 01:44 The balance sheet is as of a particular date.
  • 01:48 The reason that it's as of a date is because the checking account balance
  • 01:53 represents every deposit and
  • 01:55 every withdrawal for the entire history of the account.
  • 01:59 The same is true for the savings,
  • 02:01 the accounts receivable, the inventory, and so on.
  • 02:05 An important part of looking at the balance sheet is just asking yourself,
  • 02:10 do these numbers seem about right?
  • 02:13 When looking at the bank accounts,
  • 02:15 does that seem like approximately the amount of money in the bank?
  • 02:20 When reviewing accounts receivable,
  • 02:22 does that seem like about the amount of money that people owe?
  • 02:27 What about the inventory, does that feel about right?
  • 02:33 Moving down into the liabilities, also known as the payables, does this number
  • 02:39 seem about right for how much the company owes other companies and individuals?
  • 02:45 Does the credit card balance feel appropriate?
  • 02:49 What about things such as payroll taxes, sales tax, loans?
  • 02:54 Are those all about right?
  • 02:56 For my second example, I'm using FreshBooks.
  • 03:00 I'll navigate to Reports on the left-hand side of my screen.
  • 03:04 In the lower left-hand corner,
  • 03:06 I'm going to select Balance Sheet in the section called Accounting Reports.
  • 03:14 It will encourage you to do the same steps that I showed you using QuickBooks Online.
  • 03:19 If this is your balance sheet, look at the cash,
  • 03:22 make sure it feels like it's about right.
  • 03:25 Look at the money that people in businesses owe the business.
  • 03:29 Look at the liabilities, does this money owed to others seem about right?
  • 03:36 The equity takes a lot of getting used to.
  • 03:39 There's going to be positive numbers and negative numbers, and
  • 03:42 some of those are going to be completely valid and completely appropriate.
  • 03:47 If you're taking this course because you've not had much exposure to financial
  • 03:52 statements, it will encourage you to get very comfortable looking at the assets,
  • 03:57 very comfortable looking at the liabilities.
  • 03:59 And if you're not ready to really understand the equity section of
  • 04:03 the balance sheet, that's okay.
  • 04:06 Put that on your list of things to take a look at and really get to know later.
  • 04:11 The equity section of a business's balance sheet can really vary a lot from
  • 04:15 business to business.
  • 04:17 So in this course I'm choosing not to emphasize it.
  • 04:21 I'm choosing to emphasize that 90% that I think will really
  • 04:25 really help most of the audience, leaving you just a little bit to
  • 04:30 determine on your own, or through the help of a coach, or a mentor.

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