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Where did the Money Go? An Introduction to the Balance Sheet

Over the past 10 years working in the accounting industry, I have heard from clients time and time again, “If I made that kind of money, where did it all go?”

Clients are often very familiar with the profit and loss statement as it becomes a crucial tool for monitoring the overall health of their business. It is an essential component to effectively managing the business. The profit and loss statement reports all income earned by the business less all expenses incurred, resulting in the net income. The report can be run in two ways, accrual and cash. Accrual is best for management purposes as it shows the true picture for the period of what has been earned and the expenses associated with the same period. The cash basis profit and loss statement reports only what has been collected and paid out for the period.

The problem I often see however, is that clients equivalate this net income to the cash that should have been available for owners to draw for the period. They fail to take into account items that are reported on the balance sheet.The balance sheet is comprised of three sections: Assets (what the company owns or is owed), Liabilities (the debts of the company), and Equity (the accumulative value of the company and distributions to its owners). Changes to these accounts that require cash out of the business other than owner draw can include an increase in assets of the business such as accounts receivable, investments into new equipment and infrastructure; or reductions in liabilities such as loans, credit cards or other outstanding debts.

Increases in accounts receivable can also have a negative impact on your business. Your profit and loss may show that you have earned more, but if you have not collected it from your customers it can make it difficult to operate and restrict cash flow. An Accounts Receivable Aging report should be run on a monthly basis and a process should be put in place to address customers with debts over 30 days such as referral to collections, or changing their terms to cash on delivery.

Acquisition of items that are used in connection with the business such as machinery, vehicles, furniture, building improvements, etc; (often referred to as fixed assets) are cash out of the business that does not get recorded in the net income. They are reported on the balance sheet as they have value that lasts more than one year and acquisition of them adds to the value of the business. Each year depreciation is deducted on the profit and loss and accumulated depreciation is recorded against the value of the assets to report the decrease in the value from use. Purchases should be planned in advance and the cash needs for the assets should be deducted from the budgeted net income to ensure the company can afford the new assets.

In many cases fixed assets are financed which increases the liabilities of the company, but the monthly payments on the debts should still be accounted for in the planned budget. Debt that is paid down is also a cash outflow to the business that is not considered in the net income line of the profit and loss. The interest paid on monies borrowed is deducted against income and reported in net income, but the payments against principal are not. When planning, the expected decrease in liabilities should be accounted for as a planned cash out after the net income.

When reviewing the health of a business, business owners should review the changes to the balance sheet for the period in addition to the profit and loss statement. This will give them a better picture of where the money they have made has gone and help to assist in proper cash flow planning. To plan cash flow properly and avoid a cash crunch cash outflows to the balance sheet should be included in the budget as a decrease after the net income. Failure to plan property can result in a company that has made money during the year and still does not have any cash.

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