Reading the statements
What you own, what you owe, on one day.
An income statement covers a stretch of time. A balance sheet is a photograph. It's true on one date and no other. That's why it always carries a date at the top, and why two of them are only worth comparing if you know both dates.
You can build your own balance sheet now, starting from $40,000 in cash like the example below.
There are three parts, always in the same order. What you own. What you owe. What's left over for the owners. That last part is where the trick is, because it isn't typed in anywhere. It's whatever is left.
Here's a small one. A young company, a year or so in.
| Assets | |
|---|---|
| Cash | $40,000 |
| Accounts receivable | $18,000 |
| Inventory | $12,000 |
| Equipment, net of depreciation | $30,000 |
| Total assets | $100,000 |
| Liabilities | |
| Accounts payable | $14,000 |
| Accrued expenses | $6,000 |
| Deferred revenue | $9,000 |
| Term loan | $35,000 |
| Total liabilities | $64,000 |
| Equity | |
| Paid-in capital | $50,000 |
| Retained earnings | ($14,000) |
| Total equity | $36,000 |
| Total liabilities and equity | $100,000 |
| Check: assets less liabilities and equity | - |
A figure in parentheses is a negative one. Retained earnings can sit below zero for years, and on its own that says nothing bad. It only means the company has lost more than it has made so far.
What each part is
Assets are everything the company owns that's worth something. Cash first, because it's the one that pays for things. Then money customers owe you, then goods on the shelf, then the equipment, shown after the depreciation that's been taken off it.
Liabilities are everything the company owes. Suppliers you haven't paid, costs that have piled up, money customers have handed over for work you haven't done, and the loan.
Equity is what the owners put in, plus every dollar of profit the company has ever kept and not paid out. In this example that second part is negative, because the company has lost $14,000 more than it's earned since it started.
Why it balances
Because equity is defined as assets minus liabilities. It isn't measured separately and then compared. Everything the company owns was paid for either by somebody it owes or by its owners. So the two sides describe the same pile of stuff from two directions.
Which makes the balance a test rather than a coincidence. If the two sides don't meet, an entry upstream is wrong, and you know that without hunting for it.
What accrued expenses actually mean
Work that's already been done for you that you haven't paid for yet, and often haven't even been invoiced for. Half a month of salary that pays out next week. The electricity the meter has been running up. The accountant partway through a job.
It's a real obligation on the date of the sheet, so it belongs in liabilities whether or not a piece of paper exists. Leave it out and the company looks better off than it is by exactly that amount.
What deferred revenue actually means
Money you've collected for something you haven't delivered yet. A customer pays for a year of service in January. You've got the cash in January and you owe them eleven more months of work. So eleven twelfths of what they paid is a liability. It shrinks by a twelfth each month as you earn it.
This is the line that surprises people. Cash went up and revenue didn't, and the difference has to live somewhere. It's also why a company with a lot of deferred revenue can look flush. It can still owe a year of work it hasn't done.
Where are sales on a balance sheet?
They're not, and that catches nearly everybody the first time. Sales are on the income statement, because they describe a stretch of time, and a balance sheet describes one day. Asking a balance sheet what you sold is like asking a photograph how fast the car was going.
What a sale leaves behind does show up here. If the customer paid you, it's in cash. If they haven't paid yet, it's in accounts receivable. If they paid in advance for work you owe them, it's in deferred revenue, on the other side. And the profit on that sale, once the costs come out, ends up in retained earnings under equity.
So if you're hunting for a sales figure, the income statement has it. The balance sheet tells you what happened to the money afterwards.
The check that proves it ties
Assets, less liabilities, less equity. The answer is zero on every date, or the model is wrong. There's no partial credit here and no rounding tolerance worth having.
In this app that's the last row of the balance sheet. It reads as a dash in every column, the way it does in the table above. If a figure ever appears in it, something needs finding before the pages go anywhere.
What the full model adds
- You never type equity. It's assets less liabilities at the start, then it rolls forward with profit, money raised and money paid out.
- Receivables and payables are worked out from the days you actually collect and pay in. They're not a figure you guess and then forget to update.
- Deferred revenue builds itself from customers who prepay, and unwinds a month at a time as the service gets delivered.
- The check row runs on every month of the plan, so a change in one assumption can't quietly break the sheet three years out.
Building the model is free. Saving it to your account, the Excel workbook and the print pack are on a paid plan. The pricing page lists what comes with each one. If you want the wider view first, here's how the three pages fit together. The next page along is the cash flow statement.