The Balance Sheet

Written By Geoff Burns
Who doesn’t like a good ALE? Ok, bad joke. For accounting professionals, ALE is the accounting equation which is A=L+E, or Assets = Liabilities + Equity. But what does that mean, and why is it so important? While most business owners have heard of the ALE accounting equation, few truly understand how to set it up and use it properly. Since ALE is the basis of the balance sheet, we will look at how to setup the equation properly so your balance sheet is accurate.
Before going into the details of the balance sheet we need to look at what time frame the report covers. Unlike an income statement that shows financial change over a period of time, the balance sheet is an instant in time. For some, this distinction is difficult to understand. Simply put, the balance sheet is a statement of what you own and owe on any given day.
Assets
So what are “Assets?” Assets are tangible items of value. Cash, inventory, real property, vehicles, equipment, etc. are all types of assets. Assets are accumulated, bought and sold over time. Some assets have a limited lifespan (printers), while others may be indefinite (land). If you sell and asset for more than it is worth, it is a GAIN, and if you sell an asset for less than it is worth, it is a LOSS. The cumulative value of all assets is the “A” in the A=L+E equation. Now lets look at the right side of the equation.
Liabilities
Liabilities are the amounts owed on assets and incurred during the course of doing business. For example, if you bought a truck for $30,000, but you took out a loan of $25,000 to purchase the truck, and paid $5,000 in cash, you now have an asset of $30,000 but a liability of $25,000 in the form of a loan. You may also have liabilities for any bills that you have not paid, or if you carry a balance on your credit card. Taxes such as payroll and sales tax are also liabilities.
Equity
Equity is the amount of investment by shareholders as well as net income and retained earnings. For small businesses, the shareholders may simply be the owner. If the owner invests personal funds to subsidize the business, this is “owner equity.” Retained earnings are the profits that are used to pay off debt, or reinvest in the company. The remainder is distributed to shareholders.
A=L+E
So when we add up all of the Assets, that number will be equal to the sum of liabilities and equity. If they are not in balance, then we missed something. One of the most common errors is listing revenue or expenses in the balance sheet. If you use traditional number codes for your chart of accounts, only the 1000, 2000, and 3000 series codes should be on the balance sheet. If that just confused you, it is simple. Assets are listed as 1000 series, Liabilities are 2000 series and Equity is 3000 series. Your CPA will know this, so don’t worry if it is foreign to you.
While the balance sheet is a critical financial document, it does have some limitations. It shows no trends. It is merely a picture of what is owned and owed on a specific date. It doesn’t show cash flow. It cannot tell if you are making money. However, combined with the Income Statement and the Statement of Cash Flows, the Balance Sheet plays an integral part in helping to paint the overall financial picture of the business.
Share this:
- Click to share on Twitter (Opens in new window)
- Click to share on Facebook (Opens in new window)
- Click to print (Opens in new window)
- Click to share on LinkedIn (Opens in new window)
- Click to email a link to a friend (Opens in new window)
- Click to share on Pinterest (Opens in new window)
- Click to share on Reddit (Opens in new window)