The Balance Sheet—Or How Not to Drive your Accountant Batty
By Cynthia L. Finkenbinder, CPA
Sometimes doing accounting for my clients drives me nuts. But it doesn’t have to be that way. I get frustrated when my clients try to overcomplicate things and inevitably end up not giving me all the necessary information to get their work done. Every year I encounter someone who gives me a handwritten list or an Excel spreadsheet with their income and expenses on it—which is fine for personal taxes, but for a business it leaves many blanks that must be filled in. Every year, I must go back to them and get important data, such as the balance of their checking accounts, or find out if they paid a loan off or left out some other piece of information that they didn’t think was important. This has got to be one of the most irritating things that accountants—especially those who do taxes—deal with. Why would it cause me frustration and why am I complaining to you about it? The frustration comes from business owners who run their business more like a hobby; when they don’t have proper financial statements, it often means they also don’t have the receipts and other documents to back them up. When filing taxes, this can be disastrous.
I am telling you about it because, in the cannabis industry, having impeccable records—not just good records—is essential. Did you know that, under audit, most businesses lose several deductions because they can’t locate a receipt or because the auditor cannot easily find the reason for the deduction? Incorrectly classifying a cost-of-goods expense as a regular business expense (which cannot be deducted on your federal return), will get the deduction thrown out. While we don’t want to make the IRS auditor’s work easy, we also don’t want them hanging around our business any longer than necessary. That is the reason for following proper accounting practices, which in turn, produces good, reliable, clean financial statements.
Properly-crafted financial statements are the foundation of good business practices—they are the only way to know if you have really achieved your goals. Basic financial statements are made up of three reports: The Balance sheet, Income Statement and Cash Flow Statement. Other reports are often added, such as Movements in Equity, Budget Variance, Business Performance, Executive Summary and a Statement of Owners’ Equity, and that is just to start—some large companies have additional reports that can be as long as 1000 pages or more.
Often though, business owners solely focus on the business’s Income Statement because it shows them if they are making any money. But in focusing solely on that one report, they overlook the most important information which is the Balance Sheet. Without this report, you cannot identify areas of the business that are creating new opportunities, nor can you spot things that are causing problems for your business.
So, let’s start by looking at a basic Balance Sheet:
We’ll start with Assets—those are the things you own or are owed to you. Assets are broken into several categories including cash, current assets, property, other assets, intangibles and investments, etc. In our example above, we will deal with only three categories. We have $161K in cash at the end of 2016 whereas last year we were at $115K. This is a good thing most of the time; it typically means we are doing well at getting money in. However, it may also mean that we have not been paying our vendors in a timely manner. It could also indicate that we may want to look at putting some long-term investments in place in which to hold the money until it is needed.
Current assets are those things that should be converted to cash or used up within one year. Accounts receivable trending up could mean clients are not paying in a timely manner, which isn’t good, or it may indicate that the sales team is extending credit more often (also not necessarily a good thing), or it could simply mean that sales have gone up, which is a good thing. Prepaid expenses are items, such as insurance, that is paid for the entire year but only a portion is used up each month. Inventory going up could mean you have items that are not selling, or demand is up so you must keep more on hand than before. By paying attention to these numbers, you can get an overview of the health of your business.
Long-term assets are those assets that take more than a year to use it up. For example, buildings and equipment, which we hope to get use out of for an extended period. This can also include things such as investments, CDs and loans you give to other businesses or people, and intangible assets such as a patent you’ve purchased.
We then move onto Liabilities, which are broken into current liabilities and long-term liabilities. Here the same principle applies as for assets: If the liability will be paid off in one year or less, it is current and everything else falls into long-term liabilities. Per the American Institute of CPAs (AICPA) and Generally Accepted Accounting Principles (GAAP) guidelines, long-term assets must be broken down into which long-term and short-term portions; however, for small and mid-sized companies that is a lot more work than is necessary. That level of detail is also not necessary for tax purposes, either. (When we ultimately get down to it, filing taxes is why you need to keep your accounting records in the first place.)
The final section of the Balance Sheet is the Equity section. This tells you how much of the company is yours. This section can have several different components, depending on the type of business entity, such as a C-corporation or S-corporation, which will have common stock and dividends; or Partnership, which will have partners’ ownership and distributions. Current Year Earning is the tie-in to the Income Statement and is the profit at the end of the current year. Retained Earnings are the earnings from prior years that have not been distributed to the shareholders or partners.
Now that we have all the sections it is important to remember that they must balance—hence the name balance sheet. When you add all the Liabilities and the Equity together, that number must match the Total Assets. Getting this basic information together will make it easier for your CPA to help you make sure your business is healthy, and will keep them from going nuts. With this information in hand, all sorts of fun things can be done with the Balance Sheet, such as running a ratio analysis to see whether your current assets are enough to pay your current liabilities. Next month, we will take a look at the Income Statement, and then we’ll finish with the Cash Flow Statement.
We are also putting together webinars starting in May on accounting—specifically for the cannabis industry. Stay tuned for more information on signing up for those.
Cynthia L. Finkenbinder, CPA is the owner of Alpha Omega Accounting, LLC in located in Northern Colorado. Need help making sense of your Balance Sheet? To have Cynthia run an analysis of your Balance Sheet, or any other Financial Statements for your business, send her an email at firstname.lastname@example.org or visit her website: http://alphaomega-acct.biz