If you are like most small business owners, you barely glance at the Balance Sheet and go straight to the Profit & Loss Statement (also known as the Income Statement). But there is a lot of value in reviewing this report. In this article, we discuss the main components of the Balance Sheet. We also discuss why you should review the Balance Sheet on a regular basis.
The Accounting Formula and the Balance Sheet
The Balance Sheet shows your financial position as of a specific date. Here is the Accounting Equation:
Assets = Liabilities + Equity
Let’s breakdown the three parts of the Balance Sheet – Assets, Liabilities and Equity. This will help you to know what you are looking at.
Assets are things you own. Typically these include cash, money in the bank, money owed to you (receivables), inventory, equipment and other property.
A debit will increase an asset account. A credit will decrease an asset. Most assets will have a debit balance, except for an account such as Accumulated Depreciation which represents the amount expensed over time of a tangible asset such as equipment or other properly.
Liabilities are things owed. Typically these include money owed to others (payables), credit card debt, payroll taxes due, sales tax due, and loans.
A debit will decrease a liability account. A credit will increase a liability account. Most liabilities will have a credit balance.
Equity is what the owners of an entity have invested in an enterprise. This can include stock, owner’s investment and the value left in the business after the assets are used to pay off any outstanding liabilities.
Typically the net amount of the income less the expenses for the current year will show up on the Balance Sheet under the account “Net Income”, and the net amount of the income less the expenses for all periods before the current year will show up under the account “Retained Earnings”.
A debit will decrease an equity account. A credit will increase an equity account. Most equity accounts will have a credit balance.
What Does it Mean if Your Balance Sheet Is Wrong?
If a transaction appears on the Balance Sheet that should appear on the Profit & Loss Statement, the Profit & Loss Statement will be incorrect. This could mean that you are overstating or understating your net profit for the period.
So be sure and look at the Balance Sheet. It is as important as the Profit & Loss Statement.