Some entrepreneurs operate under the tragic illusion that recording business transactions is merely an exercise for tax purposes. But business operators with experience know their successes are due in no small way to a reliable accounting system.
Financial statements convey vital information to decision makers. The most basic report is the income statement, which shows all revenue and expenses for a specified time period. But to be really useful, an accounting system also needs a balance sheet.
Essentially, understanding the balance sheet allows you to move from the dark canyons of abstract thought into the glare of sunlight. A balance sheet indicates the amount of business cash plus spending that’s not recorded as income statement expenses. It includes equipment, furniture, and building construction.
Along with these assets, other key balance sheet components include funding sources like loans payable and capital provided by the owner. Rounding it out is the fund source that’s a sum of net profits from the entire existence of the business, offset by the part of profit distributed to owners.
Prudent entrepreneurs examine the balance sheet regularly to check on items not found on the income statement. For example, if you’re using the simple cash basis accounting method, and the balance sheet indicates accounts receivable or accounts payable, you’ll know there’s been a mistake. Those categories only occur in accrual accounting; cash basis measurement only records events only upon receipt or payment of funds. Revenue counts when cash is collected; expenses are realized when cash is paid. And a simplified balance sheet is the result.