Reading a balance sheet

A photograph, not a film

A profit & loss covers a period. A balance sheet is one date — usually 31 March, but any date will do. It answers "where does the business stand today".

The two sides

• Assets — cash, bank, stock, what customers owe you, fittings, vehicles, deposits.
• Liabilities — what you owe suppliers, loans, GST payable, anything unpaid.
• Capital — what is left over, and it belongs to you.

Assets = liabilities + capital, always, because capital is defined as the remainder. The two sides do not agree by luck or by skill; they agree by construction. "The balance sheet tallies" is therefore not an achievement — it is a symptom of the arithmetic being complete.

What your capital account is telling you

Capital starts as what you put in, then rises by profit and falls by what you draw. So over a year:

Closing capital = opening capital + profit − drawings.

If capital shrank in a profitable year, you took out more than the business earned. That is a decision, not necessarily a mistake — but it should be one you made knowingly, and it is invisible on the P&L, which never mentions drawings at all.

What a bank reads

When you ask for a cash credit limit, three things are looked at first:

• Stock and debtors, because that is what the limit is secured against.
• Current ratio — current assets against current liabilities. Comfortably above one means you can pay what falls due this year out of what turns to cash this year.
• Capital against borrowings. A business funded mostly by other people's money is a business the bank is being asked to fund further.

The number most shops get wrong

Closing stock. It sits on the balance sheet as an asset and it sets your cost of goods sold, so it moves the profit as well — one figure, both statements. A stock value taken from a guess rather than a count makes both wrong at once, and the error carries into next year as the opening figure.

That is the practical argument for keeping stock in the same system that raises the bills: the closing figure is then a consequence of the documents rather than a number somebody decided in April. Aned Book keeps stock on every edition; the balance sheet that reads it is Silver.

Which edition. Accounting — ledgers, vouchers, trial balance, profit & loss and balance sheet — is in Silver. Basic is billing and inventory: invoices, stock, parties, outstanding and GST reports, and no ledgers. Both prices are on the pricing page.

This page explains how book-keeping works so a shopkeeper can follow what an accountant is asking for. It is not accounting or tax advice — talk to your accountant before you rely on it for a filing or a return.

Questions

Why do both sides of a balance sheet always match?

Because capital is defined as assets minus liabilities. They match by construction, so matching proves the arithmetic is complete and nothing more.

Is my capital the money I can take out?

No. It is your stake in the business, and most of it is usually sitting in stock and in what customers owe you, not in cash.

What is the most common error on a shop balance sheet?

Closing stock. It is often estimated, it moves both the balance sheet and the profit, and it carries into next year as the opening figure.