Your banker knows you can never have an accurate Income Statement (profit and loss statement), without a Balance Sheet. Therefore, when the banker asks for financials and you send only an income statement, well, they put little reliance on it and ask what other kinds of collateral you may have. So, in preparation for this month’s webinar on the Basic Balance Sheet and Income Statement, let’s review a few things about the Balance Sheet that might surprise you.
There are only twelve times a year that we can issue a Balance Sheet according to the accounting gods. That’s the last day of each month. Additionally, the Balance Sheet date needs to match the dates of the income statement.
The first assignment one often receives in financial analysis is to analyze a practice set of a Balance Sheet and Income Statement. Thing is the Income Statement ends on June 30 and the Balance Sheet is as of July 15. Students typically spend hours going analyzing when they should first check the dates, found they didn’t jibe (both should end June 30 in this example), and returned their work in less than two minutes.
That’s a hard lesson to forget.
Why must a Balance Sheet be issued only on the last day of the month? After all, one can go to QuickBooks and print one any day.
It come from the fact that the Income Statement results in the Balance Sheet. I relate it to a football game. The Income Statement is the instant replay while the Balance Sheet is the scoreboard. The previous plays (Income Statement) result in the scoreboard (Balance Sheet).
So, all Balance Sheets are only issued on the last day of the month with the Income Statement starting either the first day of the year in the case of year-to-date statements and the first day of the month in the case of a monthly statement followed by a Balance Sheet that is dated ONLY on the last day of the month.
Besides, it is the monthly settling of accounts which is the reason you can’t issue a good Income Statement without a Balance Sheet.
In the end-of-month settling, we review each item on the Balance Sheet and make sure it is accurate while remembering that the Balance Sheet formula is Assets = Liabilities + Equity.
So, let’s quickly do that. Start with assets.
The Balance Sheet says we have so much cash. Do we? We usually reconcile our bank statement and compare with what our Balance Sheet. If we’re short, then that usually means we haven’t recorded an expense and find and record it. If we can’t find it, we often expense the shortage to a cash over/under account. Obviously if we didn’t reconcile this account our Income Statement could be wrong.
Inventory, which some overlook, is important. If you purchase $10,000 of paper for a big job that hasn’t yet been invoiced, then your paper inventory has increased by $10,000. But without making an inventory adjustment which effects your cost of paper (direct materials), it looks like you have used $10,000 more paper than you have and that decreases your earnings by $10,000 meaning your Income Statement is wrong.
Another common adjustment is with Accounts Receivable. Assume you have $100,000 in Accounts Receivable but $25,000 is 120 days out from the date of invoice. Most importantly, that’s 25% of your total receivables which should be no more than 10% if that.
Almost always this means some, if not all, is uncollectible which we would “write off” to bad debt expenses meaning we’d reduce receivables and expense it to bad debts. This reduces your income and, once again, effects your Income Statement.
As an aside, don’t stop collecting because if you do collect, you can easily “write it back on” through a reversal of that entry.
Those are the common adjustments among assets. Of course, if you bought or sold equipment during the period, those adjustments would be made. We’d normally get our outside accountant involved for that’s a trickier entry.
Then we go down the liabilities side and do the same thing. Do our accounts payable listed total to what we owe, etc.? Are notes payable what we owe?
Every adjustment made on the Balance Sheet typically modifies the Income Statement some way. That’s why the banker doesn’t trust just an Income Statement and you shouldn’t either.
Tom Crouser is chairman of CPrint International, a printing industry consulting firm specializing in companies with fewer than 25 employees. You may reach him at firstname.lastname@example.org or call his cell (304) 541-3714. No cost or obligation.