When I think of the Balance Sheet, I'm reminded of a meeting I had with a client in 2003. He operated a monument business (you know . . . tombstones, memorials, markers). His name was Terry and he had been in business for a little over 1 year (15 months to be exact).
On average, Terry was working 60 hours per week, but he had no idea if he was making money or losing his shirt. He was considering closing his business and getting a job. He called me up to get my advice.
I agreed to meet only if his books were up-to-date and he was able to present his financial statements. This was no problem for Terry because from day one, he had been purchasing the services of a local bookkeeper to keep his books in order. He HAD been listening in my classes!! :)
When we met, I spent about an hour reviewing his operation, trying to understand all the variables of his business. Afterwards I delved into his numbers.
When he presented his monthly financial statements, I noticed right away that the Balance Sheets were missing. He only presented to me his Income Statements (covered in Chapter 2 of FastTrack Bookkeeping) and they showed monthly profits, but they were totally useless to me without the Balance Sheets.
Who cares what the Income Statement suggests if you cannot verify financial position, I thought.
The Balance Sheet shows many things, but two are very important: financial position and accuracy.
Financial Position gives the reader a look at the "lay of the land" in a business. How much money does the business have? How much does it owe? How much is it owed? How much has the owner invested . . . and does the owner continue to invest? Is the bank balance going up or down? Are the receivables and payables going up or down? All of these things together paint a picture of the health of the business which we call financial position!
Accuracy lets the reader know if they can trust the financial statements . . . or not. It’s pretty simple actually. If the Balance Sheet does not balance, then DON’T TRUST THE FINANCIAL STATEMENTS! That’s pretty much all there it to that! Think about it . . . in Chapter 1 of FastTrack Bookkeeping, we show that the Balance Sheet must balance for a reason . . . and if it doesn’t . . . there’s a problem!
In Terry’s case, he hadn’t been receiving Balance Sheets from his Bookkeeper despite paying $150 per month for her services.
When I delved deeper into the situation (and with his permission I actually called the bookkeeper), I learned that she had been unable to get his Balance Sheet to Balance since his first month in business (no kidding!!!)
After drilling down, I learned that she had not been completing his monthly Bank Reconciliations (covered in detail in Chapter 9 of FastTrack Bookkeeping).
Because she was not balancing his Bank account, the domino effect was an inability to balance the books.
She admitted that she was purposely withholding the Balance Sheets because she couldn’t balance them. She also offered that she felt justified in taking Terry's $150 per month because, in her opinion, he was still getting value for her service. (OMG!!)
This is absolutely a true story . . . I’m totally NOT kidding.
I felt sorry for the Bookkeeper. I think she was in over her head. Perhaps she understood the mechanics of Bookkeeping, but somehow throughout her training she missed the part about “process.”
Understanding how to “classify & record financial transactions” is top of the list for a Bookkeeper’s job description.
Next is a solid understanding of “month end processing.” Proper processes, if practiced routinely, will keep the books, and by extension the “financial universe,” in order.
I remember my Mother (who is a seasoned Bookkeeper) telling me once that she spent a whole day looking for a penny. I was only 7 or 8 at the time but I was quick to offer her a penny. I mean, after all, as a kid, I was rich with pennies and I didn’t want Mom to work so hard and long for something so small!
Then Mom explained how Books that are out of balance by an amount as small as 1 cent, can actually have a much larger problem.
I may not have totally understood it then, but I certainly do now! It’s not about the penny . . . it’s about the problem.
In Terry’s case, the imbalance in his books pointed to a problem with his Bookkeeper!
The solution was simple. He fired his Bookkeeper and hired a new one.
There was still the issue of Terry's question, “am I making money or losing my shirt." I highly doubted that the income statements painted an accurate picture of profitability, so I asked 3 questions about financial position that Terry was able to answer;
1. Is your Bank account balance going up or down? ANSWER: staying the same
2. Are your Receivables going up or down? ANSWER: going up
3. Are your Payables going up or down? ANSWER: “What Payables?" (good answer!!) ;)
I was reasonably certain that he was NOT losing his shirt, but I was not in a position to advise him until I reviewed his properly completed financial statements.
Several weeks later I met up with Terry to review his “new and improved” financial statements.
As I suspected, the “old” income statements were over-stated . . . for many months he had only broken even, and for two months he actually lost money, but for the most part, his business was profitable. In fact, he was making enough money to pay himself a moderate salary the following year.
He decided to keep the doors open. After several years of slow but steady growth (which is the BEST kind incidentally), in 2011 he purchased his own commercial property from which to operate. He continues to operate a strong and successful business . . . with his new Bookkeeper!
You don’t have to understand bookkeeping to know if the financial statements are correct. I mean, anyone can identify if a Balance Sheet does not balance – and that’s a dead giveaway that something isn’t quite right. However, understanding how to process books will give you the ability to read and analyze financial statements.
It’s no mistake that ALL Business Administration and Commerce programs mandate Bookkeeping & Accounting as part of the curriculum. The language of Business & Commerce is best learned by understanding Bookkeeping. The first concept is Balance.
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