Preface: “One’s destination is never a place, but always a new way of seeing things.” — Henry Miller.
“Success is about dedication. You may not be where you want to be or do what you want to do when you’re on the journey. But you’ve got to be willing to have vision and foresight that leads you to an incredible end”. — Usher
Navigate Business with a Good to Great Balance Sheet (Segment I)
Credit: Jacob M. Dietz, CPA
Where is your business, and where is it going? Good to great financial reporting helps answer these questions, but too often the accounting records of a business cannot be trusted because of inaccuracies. If you want more accurate numbers, take the time to clean up your balance sheet. Trying to navigate a course for your business using inaccurate financial reports can be like trying to navigate with a 50-year-old atlas. You may miss your intended destination on the journey. Alternatively, you might reach your destination, but it may take you on a long route. Using accurate financials can help you reach your goals on your journey.
If you crave an accurate profit and loss statement and statement of cash flows, start with an accurate balance sheet and end with an accurate balance sheet. If the balance sheet is wrong, then the profit and loss statement and the statement of cash flows may be wrong as well.
If the balance is wrong, how do you fix it? Begin with the beginning balances. Generally, treat the balances that were used to prepare the last tax return as correct. If the tax return contains significant problems, however, then consider starting with balances used for an earlier tax return. For this example, assume that there are no known problems with the last tax return. Let’s explore how to generate accurate balances.
The first part of the balance sheet lists what the company owns. Accountants call these items assets. Assets include bank accounts, inventory, accounts receivable, etc. Verify that the beginning balances for the year equal the ending balances used for the tax return. In a balance sheet, the asset ending balance for the previous year is the beginning balance for the current year. Sometimes accountants adjust the balance sheet when preparing the tax return but don’t adjust the company’s accounting records. If the beginning balances do not tie, adjust the balance sheet dated at the end of the previous year to tie the beginning balances to the ending balances used for the tax return.
What adjustments might be made by an accountant but not entered in a company’s accounting records? Accountants frequently adjust inventory at year end through cost of goods sold. If your accountant adjusted inventory for the tax return, but that adjustment was not made in your accounting records, then adjust your inventory to match the inventory that was used on the tax return. Accountants frequently adjust depreciation when preparing a tax return. Depreciation adjustments affect the balance sheet account Accumulated Depreciation. If Accumulated Depreciation in your accounting system doesn’t match the balance sheet used for the tax return, then adjust it to match.
If all the beginning balances match the ending balances used on the last tax return, examine the ending balances of the period being considered. A balance sheet is a snapshot of a company’s finances at a specific point in time. It is therefore important to know which date is being considered. For this example, assume that the balances are for December 31. Examine every line item in the asset section of the balance sheet, and consider if it is accurate.
Start with cash. If petty cash is listed on the balance sheet, is it accurate? If there is only $25 in the petty cash drawer, but the balance sheet says $1,500, then adjust petty cash to match the counted value. If an item is small, judgment can be used regarding how much verification to do. For example, if petty cash says $45, you might decide to skip counting petty cash since it is insignificant.
Verify the ending balances for bank accounts. Each account should have either a bank statement or a bank reconciliation that ties to the amount on the balance sheet. If a checking account has outstanding checks, review the outstanding check list to see if there are any old items there. For example, suppose there are 2 checks listed from 11 months ago. Why did those 2 checks not clear? Were they duplicated in the accounting system?
If there is inventory on the balance sheet, is it counted regularly? Many companies need to count inventory regularly or else the balance will be incorrect. If the balance differs from a physical inventory count, then adjust the balance to match the count.
When inventory is adjusted, the other side of the adjustment is cost of goods sold, which is on the profit and loss statement. If the beginning and ending inventory balance is not correct, then cost of goods sold may also be wrong, leading to an incorrect profit and loss statement. Therefore inventory, a balance sheet account, impacts cost of goods sold on the profit and loss statement.
If the company has accounts receivable (AR), examine an aging report for accuracy. Does the report list amounts that will never be collected? Consider if any AR should be written off as bad debt.
If there are other items in the asset section of the balance sheet, consider if they are accurate. Also, consider if there are items that are not in the asset section that should be. For example, did the company loan money to another company? If so, ensure that the loan receivable is recorded in the accounting system.
Segment I Summary: Where is your business, and where is it going? Good to great financial reporting helps answer these questions, but too often the accounting records of a business cannot be trusted because of reporting inaccuracies. The above steps as a good beginning step, with the guidance of your CPA, can begin to create an accurate map of your business financials.