Costs
Part of A balance sheet is a single date, not a period, and that changes everything
Balance sheets framework: agreeing eight lines to documents
A balance sheets framework that agrees eight common lines to a document outside the ledger, with a check frequency, and orders every line by timing.
The balance sheet covers a moment, so it can only be trusted one line at a time. A framework for it pairs each common line with a document outside the ledger, a check frequency and a reason it sits where it does.
All amounts below are invented to show the structure.
What to take away
- Balancing proves the bookkeeping is internally consistent and nothing else. A fictional stock figure balances against an equally fictional profit.
- The real test is whether every line can be agreed to something outside the ledger.
- Checks run on different clocksmonthly for bank, receivables, payables, loans and accruals, yearly for equipment, at least yearly for stock.
- A line with no schedule is a line nobody can defend, so lines not in the table need their own.
Why balancing says nothing about a line
A balance sheet balances automatically, because every transaction is recorded twice. That is why balancing cannot show that any single line is right: wrong entries are posted twice as well.
One transaction, two entries
- Sell 500 on terms
- Receivables +500
- Retained earnings +500
- Buy 900 machine on credit
- Assets +900
- Liabilities +900
That is the first thing a course in financial accounting establishes, and everything else on the statement follows from it. Sell 500 on terms and receivables rise 500 while retained earnings rise 500 through the profit. Buy a 900 machine on credit and assets rise 900 while liabilities rise 900.
No combination of correct entries unbalances it. No combination of wrong ones does either, provided each was posted twice. The sheet balances by construction, so the effort has to go into the schedules below.
Eight lines, each agreed to an outside document
Match each of these lines to a document outside the ledger that supports its balance. The table groups them by how often that document is agreed, which turns the statement into a month-end to-do list.
| How often | Line | What agrees it |
|---|---|---|
| Monthly | Bank | The bank statement, reconciled |
| Monthly | Receivables | The customer ledger, totaled |
| Monthly | Payables | The supplier ledger, plus supplier statements |
| Monthly | Loans | The lender's own balance and schedule |
| Monthly | Prepayments and accruals | A schedule listing each item and its release |
| Each period | Tax accounts | The return or the authority's own statement |
| Yearly | Equipment | An asset register listing each item |
| At least yearly | Stock | A physical count valued at cost |
A line with no schedule is a line nobody can defend. In practice, the accounts that go wrong are always the ones missing from a list like this.
The ones most often missing are stock, tax control accounts, and anything called suspense. The IRS recordkeeping guidance notes that purchases, sales, payroll and other transactions generate supporting documents, and those documents hold the information to record in the books.
Getting each of these to have its own account, rather than being folded into a general one, is a chart of accounts decision made long before the balance sheet is produced.
Where each line sits
Lines are ordered by how soon they turn into cash, or how soon they have to be paid. The order tells a reader which schedule belongs to which section of the statement.
| Section | Contains | Ordered by |
|---|---|---|
| Current assets | Cash, receivables, stock, prepayments | How soon it becomes cash |
| Non-current assets | Equipment, vehicles, long-term deposits | Held to use, not to sell |
| Current liabilities | Payables, tax due, the next year of any loan, deposits held | How soon it must be paid |
| Non-current liabilities | The rest of the borrowing | Due beyond a year |
| Equity | What the owners put in, plus profits kept in the business | What is left |
Balance sheet line order
Assets
- Within a year
- Current assets
- Beyond a year
- Non-current assets
- Owners
- -
- Ordered by
- Speed to cash
Liabilities and equity
- Within a year
- Current liabilities
- Beyond a year
- Non-current liabilities
- Owners
- Equity
- Ordered by
- Speed to payment
The dividing line in both halves is a year. That is a convention, not a law of nature. It exists so a reader can compare the top of one column with the top of the other. Current assets against current liabilities is the question of whether the next year can be paid for.
Two placements catch people out. The portion of a loan repayable within the year sits in current liabilities even though the loan is long term, so a single borrowing appears in two places. And a customer deposit is a liability, not income, because the business owes work.
How the lines tie together at month end
Between two dates, four movements link the lines, and each one gives a tie-out for the close.
- Retained earnings move by the profit for the period. That link to the profit and loss statement is the tie between the two statements, and if it does not hold, something was posted outside the ledger.
- Receivables move by sales less cash collected.
- Payables move by purchases less cash paid. The accounts payable framework sets out who may release those payments.
- Cash moves by everything else, which is exactly what the cash flow statement is built to explain.
Those four sentences are the whole relationship between the three statements. A business that can say them out loud about its own numbers has understood its books.
Reading one in five minutes
Take a balance sheet and ask, in order:
- Current assets against current liabilities. Can the next year be paid for out of what is already owned or owed to us?
- How much of current assets is cash, and how much is receivables and stock? Those two are promises, not money.
- How old are the receivables? The balance sheet does not say, so ask for the aged report.
- Is there a suspense or unclear account with anything in it? Whatever is in it is an unanswered question.
- Does equity include amounts owed to or from the owner, and are those separate from trading balances?
Five questions, five minutes, and it will find more than an hour of reading the profit statement.
