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Thanks for joining us for another episode of ask a spiral CPA. Uh, today we’re talking about understanding your balance sheet. I Have Laura here with me once again. So, uh, I, Laura, how was your, your first t four key five season? What was that? A lot. A lot of emails to process. So, um, yeah, we were happy to be, be clear of that for, for another month here. And the quote that I have, you know, they’re dealing with our topic, understanding your balance sheet today is, is Albert Einstein. If you can’t explain it simply you don’t understand it. And that, you know, is, is, is great. And I think of a balance sheet and the questions people have on balance sheet and the explanations they get some time and they know if it’s not a simple explanation, it’s usually wrong. Um, so the statistic, you know, 50% of volcanes small business, you know, don’t make it past five years.
And you know, the ones who do, sometimes they have challenges as well. And you know, one of the big three reasons why they fail is they run out of cash. So, um, you know, the story is, you know, we have business owners that are making critical business decisions on an income statement, but the real information that they need is on that balance sheet, which they just, you know, don’t understand or sometimes don’t even make an attempt to understand because they think it’s so far beyond them. So Laura, what are the questions you think these business owners should be asking? Why do you always insist on looking at the balance sheet first? Yeah, so I mean, whenever you’re looking at it, especially interim financial statements, you know, there’s a high degree of risk that there’s an error in misstatement. You know, it’s, it’s not a perfect science.
You’re always balancing, you know, a reasonable budget to prepare the, the items, you know, versus, um, you know, the, the, you know, the accuracy. Right. Um, so if you, and often there’ll be a glaring error on a balance sheet and if you never look at it, you know, it’s going to show up that that balance sheet item is going to have a significant, you know, relate to a significant misstatement on the income statements. And you might, you know, decide to purchase a, a new piece of equipment or hire a new staff member or let a staff member go thinking that you, you, you can’t afford them when really you can. And if you would’ve just looked at the balance sheet first, that would have made all the difference plus the balance sheet, you know, speaks to your, your reserves and what’s coming in and you know, how, how liquid you are, how much cash you have in the bank, what are the receivables that were coming in, what are the pay payables that are going out.
So it has real critical information concerning the liquidity of the company. Um, and which is not going to be shown on the profit and loss statement. Just because you had a good month doesn’t mean you’re in a good liquid situation at all. So I always say it’s balance sheet first and then its profit and loss and that’s just the discipline that you should stick to. How does looking at a six month comparative balance sheet help? Yeah. So the six month comparative, he’s going to draw your attention to any variances, uh it can be complicated to Hire A CFO Edmonton but we make it easy, over time that don’t make any sense. So a lot of business owners and you know, they’re, they’re not CPAS, uh, but simply if they look at a six month comparative, they’ll know enough and start to gain enough knowledge to really recognize those variances. So when we present balance sheets, you know, intern balance sheets to our outsource accounting clients, you know, we’re always looking at that six month comparative because looking at one month alone, it doesn’t give me all the tools that I need to recognize that something could be misstated.
But if I look at six months, you know, I know what happened in January, February, March, April, May, June, and there’s a number that doesn’t make sense. There’s a variance that’s, you know, historically, you know, the receivables are really high, this is new prepaid or you know, the equipment when upper down dramatically, you know, it draws our attention to it. Whereas if we just looked at the current balance sheet, we would never bleed that sort of information. So that six months comparative as is the powerful tool to recognize variances, which uh, you know, may or may not, uh, you know, relate to a misstatement. That is why you need to Hire A CFO Edmonton to work with you.
Okay.
Why can cash on the balance sheet be different than the bank statement? So all the cash on the balance sheet, we have to understand, you know, it can be subject to uncleared items. So for example, if you have the cash on the balance sheet, if you’ve written checks for example, so your bank balances $100,000 and you’ve written a check yesterday for $80,000 and sent that in the mail. And the client, you know, the, the supplier hasn’t yet cash to your balance sheet is only going to shoulders. There’s plenty left. It’s assuming that that check is going to cash at some point, but your bank statement will still show that you have $100,000. So in your mind you might be thinking, I’ve got lots of money to pay payroll or really once that check clears that payroll is going to bounce. So we do understand those uncleared I, they can work the other way to own deposits. You know, checks can be outstanding for a little longer, but you know, the pause that’s are usually a little bit shorter. So, you know, you could have a deposit, you know, and they rang it through the credit card machine yesterday, but the bank balance doesn’t quite reflect it the next day. It might be, you know, two, three days before it hits the bank. So the balance sheet, bank balance has those uncleared items. Once they clear what’s the real, you know, once the smoke clears, what’s the real bank balance going to be?
Okay.
What will generally happen if your accounts receivable is under or over state? So if you have an accounts receivable and let’s say it’s overstated, you know, really people owe you $80,000, but your receivable balances showing that people owe you $100,000, you probably have an extra $20,000 of revenue book somewhere. Maybe it’s a duplicate invoice. Um, you know, maybe there’s some sort of type of error in it. So when we’re looking at that variance here, and we have an overstatement in ar, we probably have less revenue. Uh, we have probably have more revenue on the income statement then should. So again, it’s an error that you’ll pick up when you’re looking at that, hey, every month a customer is only 40,000 bucks and then this month, all of a sudden they owe me 80 grand. Okay. Do they really owe me 80 grand or was there a problem in the, in this arls thing at all? Uh, same times if there’s less ar, you know, we’ve under reported the revenue can make it look like the business isn’t making any money when really it is, you know, we’re, we’re missing that that invoice never actually got entered into the statement or an anchored enter the incorrect amount.
So
what should be added to the property, plant and equipment section? So generally added to the property, plant and equipment. These are longterm assets, you know, uh, all define that as they have a useful life of longer than a year. Um, and I, I would say, you know, just for simplicity and logistical reasons that they’re a asset value greater than 1000 bucks. It’s no point, you know, uh, counting assets that are less than a thousand dollars. You know, if they meet the technical definition, you know, it’s not material, you’re just going to drive yourself nuts. It is imortant that you Hire A CFO Edmonton. You know, maybe buy a stapler for 20 bucks and you can use it for five years, but do not put that on the balance sheet. Uh, put assets, significant assets, $1,000 or more. And you know, that’s what should go, uh, on the balance sheet. So significant assets for the useful life of a, um, you know, more than than a year. Uh, that’s, that’s what she belongs on the balance sheet, property, plant, equipment section.
What will generally happen if your accounts payable is under overstated? So it’s Kinda like the receivables, but the flip of it, so let’s say your accounts payable is understated, that means you haven’t entered all the invoices in. So you can see all the revenue on your income statement. But if you don’t have all the payables listed on your balance sheet, those expenses are understated, which means the profit looks better than what it actually is. Right? At the same time, if there’s something put in the payable section that you don’t actually intend to pay, maybe they, you know, contractor didn’t deliver and you have to go to a new contractor. Now you have the old contractors build it. You’re not going to pay on the payables and the new contractor that bill. Also on the payables, your income statement looks like you’re making less money than you actually are. So any under over a statement and accounts payable has an effect, you know, up or down on the income statement as well.
What is generally going on if your credit card balances unchanged or negative. Yeah, this is like a common one. You’ll see it in your, you’re looking at that six month comparative balance sheet. Remember it’s God’s going to give you the information and you see your credit card balance and month one is you know, $2,464 a month. Two is $1,655 and every month it’s a very precise amount and it’s always slightly different. And then you get to month five and six. You know what you’re looking at the last month and the most current month and it’s, you know, $5,438 a month. Five and $5,438 a month. Six it’s the exact same number. Is that possible? Yes. But the more likely scenario is the credit card charges have not yet been been entered onto the balance sheet. You have to Hire A CFO Edmonton to make sure you have your accounting in line. So if you were to jump straight to your income statement and make a decision on that profit and loss, you were missing expenses on that profit and loss. So the business is gonna look more profitable then otherwise then it really is and you don’t want to make decisions based on that. So, and also that’s a big one that usually jumps straight out at you. If you see that credit card balance doesn’t change from one month to the next, it probably just means that those transactions has not yet been entered. So again, you can’t make decisions on that profit and loss statement yet.
Yeah.
Why should your loan balances be decreasing every month? So if you look in, you have, you know, a loan and it say it’s a loan from the Royal Bank and you know, it started off at 100,000 and the next month it was ninety nine thousand ninety eight thousand ninety seven thousand ninety six thousand and then you know, in the two months it stays ninety six thousand ninety six thousand. Well the, that can mean a number of things, but it should draw your attention every month we’re making a regular payment on this and all of a sudden there’s a month where it stopped. So either eight we actually did make the payment and the bank is going to be upset with us. Um, you know, or be did. That payment is sitting in another account causing an air. Maybe it’s sitting in interest and bank charges or another expense account and it makes your profit and loss, you know, it makes it look like you made less money then, then you actually did when it was a principle loan repayment. Right? So this one of the common things that you look and make sure the loan payments are going down. And also that each, sometimes there’s more than one loan on each loan payments getting classified to the right account, right? Which can reduce the headache at year end and trying to prepare this thing. So
why is it okay for your corporate tax payable accounts to be negative? So this is one where normally you look at the, you know, the, the assets would all be positive and the payables should all be positive. That’s the regular balance. But corporate tax works a little bit different to most intern financials. It’s really not worth booking a tax provision month a month. I’ll usually, that’s kind of overkill and you’re getting into the area where, yeah, you can do it, but what’s the cost and the significance of that exercise? So normally what happens is you say you start a business, um, so you start a business from fresh and you want to make tax installments or you just want to, uh, you know, make sure that that money’s tied up the way it is. We’re not going to book that tax expense until month 12.
And let’s say we estimate that that tax is going to be $12,000 a year every month. We don’t have an expense, but yet we’re paying into that tax account. So what it looks is like we prepaid the tax. So when you prepaid it, you know, when you prepaid a liability, you get a negative liability on the balance sheet. So if you see your, your corporate tax accounts, uh, you know, with a negative increasing number month to month, that’s just makes your, you’re prepaying your tax month a month and you’re prepared for it because that year in that tax bill is actually going to go apply to that account. And that negative number theoretically reduce to zero.
Why should you look at the individual transactions and your shareholders? So your shareholder loan is probably the most significant account for tax purposes because not only this is income, this is income that you’ve taken out of the company. So we’re looking at, you know, not just corporate taxes but looking at personal taxes or at least salaries. So you were just looking at that share of the loan balances. You know, you might not drill into every single account when you review your, your balance sheet, which use, you’re probably view your Cheryl’s alone.Hire A CFO Edmonton is important and here is why. You know, it should be very definitive because what you’re looking for is there could be charges that, you know, someone made a thought that they’re personal but they’re really a business expense. So if they get put in your shareholder loan, um, if we put this business expense in their share of the loan, you’re going to end up paying personal tax on that business expense when that expense belongs on, you know, the a legitimate expenses for the business.
So, you know, and to try to go back on that at year end, that can be a little bit dicey because you, you start to wonder, well what the heck did I buy there? And you know, I’m sort of checking have you received, either it’s a long project or you know, something gets missed. So, you know, reviewing that Cheryl the loan, not just the balance, but that’s the one where I would say you really got to drill into the ledger each and every month and see, okay, I took $4,000 for myself and I paid my personal tax payments and that’s great. But he started to see these other expenses where they really personal in nature. Should I pay personal tax on that or were they a legitimate business expense that belongs as a, as a, as an expense items. So, uh, that’s what we have for you here today. Thanks so much for tuning in. You know, always hit that light can subscribe button. We can continue to deliver you guys tips on helping you beat the odds at business. And if you have any questions, feel free to leave them in the comments below and we’ll do our best to address it in a future video. Thanks very much.
