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Explain the importance control accounts play in balancing the model when used effectively. When to create control accounts, how to create them and where to link their line items.

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Quick reference

Control Accounts

Understand Control Accounts

When to use

It is necessary to understand how control accounts work when building a Financial Model.

Instructions

Control accounts tell you three key things:

  1. Number of calculations that need to be entered into the financial statement so that they balance: This is always one less than the number of rows in the control account. The reason it is one less is because the opening balance is simply the closing balance calculated from the period before.
     
  2. The order to build the calculations into the financial statements: This is always row 2 first, then row 3, then row 4 and so on. Think of it this way: assuming no opening balance (which there would not be in the beginning), if there were no sales, there could be no payments received. If there are no sales and no receipts, the difference between them (the amount owed, the Accounts Receivable) would also be zero. It is a logical order.
     
  3. It identifies the key driver: Often you want to undertake sensitivity and scenario analysis in your models, but sometimes you may be unsure which variables should be included in the analysis. Line 2 of the control account is always the key driver. As above, if there were no sales, there could be no payments received. If there are no sales and no receipts, the difference between them (the amount owed, the Accounts Receivable) would also be zero.

Example

In the example above, if the opening balance of Accounts Receivable is $120,000 and we make further sales in the period of $64,700, assuming there are no bad debts (more on that later) and the cash received is $82,750, then the closing balance for Accounts Receivable has to be $101,950. In other words, assuming the opening balance was $120,000, entering:

  • Sales of $64,700 in the Income Statement;
  • Cash Receipts of $82,750 (as a positive number) in the Cash Flow Statement; and
  • Closing Accounts Receivable of $101,950 in the Balance Sheet
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  • 00:04 Let's keep moving, then, as I set the scene about how we build a financial
  • 00:08 model, the order we build it in, why, and what tools are at our disposal.
  • 00:13 In particular, I want to look at a very useful tool for
  • 00:16 making the balance sheet balance.
  • 00:18 You might not know what a balance sheet is yet, but
  • 00:20 you know that the name actually implies that it balances.
  • 00:23 So that's going to mean net assets equals total equity.
  • 00:27 Let's just have a reminder from last time out.
  • 00:32 Essentially, there are three financial statements you should be modeling in
  • 00:35 a financial model, namely the income statement, the cash flow statement and
  • 00:38 the balance sheet.
  • 00:40 Link together, put in the checks, and you have it three-way integrated.
  • 00:44 That's what the point is.
  • 00:46 But, okay, so that's how they link together mathematically.
  • 00:51 How do they link together conceptually?
  • 00:54 Now, don't be put off by the fact that this slide says conceptual order.
  • 00:57 This is the conceptual order from building a model.
  • 01:00 What I want to do now is look at the theoretical concept as well, and
  • 01:03 to do that, we need to balance the balance sheet.
  • 01:06 It's always gotta work.
  • 01:07 Now bear in mind,
  • 01:08 when we build a model, we will have to have an opening balance sheet.
  • 01:13 No matter where we start from, whatever our start date is in a model,
  • 01:16 the company either exists at that point in time or it doesn't.
  • 01:20 If it doesn't, then its balance sheet is empty.
  • 01:22 There's nothing in there, and all the transactions commence thereafter.
  • 01:26 If it's already there, then it's going to have a pre-existing balance sheet.
  • 01:29 Either way, be it zero or it's populated, we're going to have an opening balance
  • 01:34 sheet that somebody, somewhere will have to give to us.
  • 01:37 It's got to balance.
  • 01:39 It's got to balance.
  • 01:40 If it doesn't balance, we mustn't accept it or we can be held responsible for
  • 01:45 in building a financial model is that the movement in net assets,
  • 01:49 the delta equals the movement in total equity, the corresponding delta.
  • 01:53 That's how we can be held responsible for.
  • 01:55 Now your day job might also mean that you have to look after the financial
  • 01:57 statements.
  • 01:58 That's fine, that's a little low on responsibility for you.
  • 02:01 But as a modeller, we can only be held accountable for the movement in net assets
  • 02:06 equaling the movement in total equity and that's going to be important for
  • 02:09 a trick I'm going to employ in the modeling shortly.
  • 02:14 The thing I want to bring up in this session in particular
  • 02:17 is the concept of control accounts to show in another way how the financial
  • 02:21 statements link together.
  • 02:22 Even if you are not an accountant, this is very useful for
  • 02:26 showing how to get the financial statements to integrate and
  • 02:29 how to get that that balance sheet to blessed well balance.
  • 02:33 Very, very simple, for
  • 02:36 example, let's assume at the beginning of a period you're owed $120,000.
  • 02:41 You've sent all these invoices out, and people owe you this amount of money.
  • 02:46 In the period, people also give you $64,700.
  • 02:48 That means at that point in time, if there's no cash coming in,
  • 02:54 and there's no bad debts to write off, you owed $184,700.
  • 03:00 You get in the period $82,750.
  • 03:02 Now I don't know if that's for money for
  • 03:06 a previous period, the current period, whatever.
  • 03:08 But I do know that going forward I've actually still got $101,950 owing to me.
  • 03:15 And this is what the control account does, it has this b/f and c/f.
  • 03:19 B/f stands for brought forward, means from the previous period.
  • 03:22 And c/f means carried forward to the next period.
  • 03:26 And this is what a balance sheet looks like.
  • 03:28 It has four or more, line items typically.
  • 03:32 And the opening and closing are always balance sheet items.
  • 03:36 No exception.
  • 03:37 Always balance sheet items.
  • 03:39 And if you think about it, the balance sheet item is just the previous period.
  • 03:43 So the top and the bottom are the same account.
  • 03:46 So we've only got three accounts here that we need to populate in the financial
  • 03:50 statements, and then it will balance.
  • 03:52 So a key rule here is that when you construct a balance sheet
  • 03:56 control account like this one, you subtract one from the number of rows.
  • 04:01 So, we've got four rows here, so you have three.
  • 04:03 And that will give you how many calculations you have to put into
  • 04:07 the financial statements to get them to balance.
  • 04:10 Now most of us were brought up on this idea of debits and credits and
  • 04:13 double entry and goodness knows what, and so
  • 04:15 there always needs to be an even number of calculations.
  • 04:18 As an accountant myself,
  • 04:20 I hear of concepts like reversing journals and things like that.
  • 04:23 A reversing journal.
  • 04:25 Let's just be clear here, let's put back what we should have put
  • 04:28 in in the first place because we had to fill it to make double entry work.
  • 04:31 If you don't follow that, good, because I'm not gonna teach you that way and
  • 04:35 the last time you're going to hear about debits and
  • 04:37 credits I hope will be in that last sentence.
  • 04:39 This is how it works.
  • 04:40 It makes sense to people.
  • 04:42 I've started off around $120k.
  • 04:46 I have $64,700 coming in.
  • 04:48 That means I'm owed $184,700.
  • 04:49 People will pay me $82,750.
  • 04:50 So if there were no bad debts which could also go in the control account if there
  • 04:55 are that would be another deduction that I'm going to be out at the end
  • 04:59 of the period, 101,950.
  • 05:01 So what if I would populate this in
  • 05:05 the financial statements 120,000 would go into the previous period.
  • 05:11 64,700 would go into the P and L for the current period.
  • 05:15 82,750 will go into the cash flow statement for
  • 05:17 the current pay period, as a positive number.
  • 05:20 Gotta remember cash receipts is a good thing and therefore,
  • 05:24 we put into the balance sheet for this period 101,950 and it would balance.
  • 05:27 And I'm gonna actually show you that when we actually build the model.
  • 05:31 This is what it's about.
  • 05:32 Three things you need to know about control accounts.
  • 05:35 How many calculations do you need to do?
  • 05:37 One less than the number of lines.
  • 05:39 The second thing is what's the key driver?
  • 05:41 And that's always the line two item.
  • 05:43 If there's no sales, eventually there'll be no accounts receivable brought forward
  • 05:47 or carried forward.
  • 05:48 And there'll be no money coming in, cuz nobody owes you anything, so
  • 05:51 there'll be no cash receipts.
  • 05:52 So a key driver should be on line two.
  • 05:55 And the third thing it tells you as well in here is the order to modelling.
  • 05:59 So we should do the sales before the cash receipts before the accounts receivable,
  • 06:02 ignore a top line.
  • 06:04 Control accounts are your friend, very, very simple.

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