This video is going to give you a solid introduction to the
balance sheet in accounting. I'm going to explain what it is,
how it's all laid out and then we're going to build ourselves
a balance sheet from scratch using Google sheets and
six example transactions.
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Hello there, welcome back to the channel!
I’m James this is Accounting Stuff
and in this tutorial we're going to cover the
balance sheet in accounting. The ‘balance sheet’ or
‘statement of financial position’ is one of the three major financial statements
along with the ‘income statement’ and ‘cash flow statement’.
So this is a big big topic. If you run a startup then you
absolutely must be able to prepare one of these in order to have a hope of
getting funding, and on the flip side
if you're ever planning on lending money too or investing in a business,
then it's critical that you know how to read and understand the balance sheet
because the balance sheet will give you an impression of the
business's financial health. And that will determine how risky
the opportunity is for you. And finally
if you're an accountant then chances are you'll be helping
prepare one of these at the end of every accounting period.
Over the past few months I've been posting weekly videos teaching
accounting basics for beginners that you can find up here.
This video is going to link a bunch of these ideas together so if you find any
parts of this explanation confusing then I recommend you check those out
to cement your understanding and come back to this one if you need to.
There will be links in the description below to all of the relevant ones so feel free
to check those out. As I mentioned I'll be
releasing new videos each week and I aim to cover all of the major parts of
the balance sheet. So hit the subscribe button
and click on the bell to be notified when those come out.
Don't know about you, but I'm itching to get cracking
I mean what is the balance sheet? Let's find out.
The balance sheet looks like this. The way it's presented can vary but
there are some key elements at the core of the balance sheet
that the rest of it's built around. Here we have a balance sheet
for a business called Craig's Design and Landscaping Services.
That's because I took this one from the sample company
in QuickBooks Online. QuickBooks Online is the
biggest cloud accounting platform in the world and they specialise
in small to medium sized businesses. So I thought this one would
make a good example. If you're thinking this all looks a bit crazy
then no worries. I'm only showing you the finished product.
We will piece together a simpler one of these for ourselves in a moment.
Right I think it's time for a definition… A Balance Sheet is a snapshot of a
business's Assets, Liabilities and Equity at a single point in time.
And that's exactly what we're looking at. We have Assets over here on the left,
and on the right hand side we have Liabilities and Equity.
Beneath both of the headers we have all of the detail.
All of the individual groups of accounts summarised with their closing balances
at the bottom of the balance sheet. We have our total assets and
total liabilities plus equity. You'll notice that both of these numbers
are exactly the same. That's what we want to see.
It’s the aim of the game here because the balance sheet as
suggested by its name always has to balance.
So your total assets must be equal to your total liabilities
plus equity. If they don't match each other exactly
then we've got a problem. In the past people used to make
their balance sheets manually and this was a pain in *beep*
You could easily waste hours, or even days trying to figure out
where the errors were in your workings. But thankfully,
nowadays accounting platforms like QuickBooks Online exist.
They ensure that your balance sheet always stays balanced.
If you run a small business and you'd like to give
QuickBooks Online a try then you'd be doing me a massive favour
if you follow my link down in the description. It's an affiliate link.
So you'll get access to a free 30-day trial and the chance to
support me making more accounting videos just like this one.
Check out the video I made up here if you're interested.
But if cloud accounting isn't for you, that's ok you can also
support the channel by giving this video a like and sharing it
with someone if you think they'd find it useful. But anyway,
I promised you that we'd build ourselves a balance sheet from scratch
and I meant it. So here we are.
We have a clean slate. We're going to build this balance sheet
from the ground up using one key principle…
Double-Entry Accounting. In double-entry accounting
every accounting entry has an opposite, corresponding entry in a different account.
Or put simply… Stuff the business owns
is equal to the stuff the business owes.
We accountants call stuff that the business owns ‘Assets’.
But the stuff that the business owes is a little bit more complicated.
We use two different words to describe it depending on
who the business owes stuff to. When a business owes stuff to
third parties like lenders, suppliers and employees
we call them ‘Liabilities’. However when a business owes stuff to
its owners we call it ‘Equity’. So we have
Assets are equal to Liabilities plus Equity.
This is the basic accounting equation and it always balances.
Total assets must be equal to total liabilities plus equity.
Now every financial transaction that a business is involved in affects
this accounting equation. So the values of our
assets, liabilities and equity are constantly changing.
But it's possible for us to take a snapshot and freeze
their values at a single point in time. When we do that
we're looking at a balance sheet. The thing is though that
these three buckets are far too broad. There are many types of
assets liabilities and equity, and it would be helpful if we could
distinguish between them. It's time for us to hop into
Google Sheets and flesh out this balance sheet. We'll begin with assets.
And FYI I'm going to move through this next section fairly quickly because
I've made a video covering assets and a lot more detail
that you can find linked up here and down below in the description.
The same goes for liabilities and equity. So check those out if you'd like
some fuller explanations. Assets are broken down broadly
into two main categories. Current assets and non current assets.
Current assets are short-term assets that can be converted into cash
within one year. Some of the most common types of
current assets are cash, accounts receivable,
supplies, inventory and prepaid expenses.
On the other hand, non current assets are
long-term assets that are used in operations to generate profit.
They can't easily be converted into cash. So we expect to hold on to them
for more than one year. Two common types of non current asset
are long-term investments and property, plant and equipment.
It's a similar situation for liabilities. We have current liabilities.
Which are our businesses obligations that need to be settled within
one year from now. These include accounts payable,
salaries payable, taxes payable and accrued expenses.
And we also have non current liabilities. Obligations that aren't expected
to be settled within one year. Stuff like long term loans.
And that leaves us with equity. The final piece of the puzzle.
This section works a bit differently to assets and liabilities.
We have two broad categories to consider. Owner's equity
and retained earnings. You can think of retained earnings
as profits held for future use and this is key because it’s the profit
in retained earnings that forms the link between the balance sheet
and the income statement. Keep that in mind.
I’ll demonstrate how it works in this next example.
But before we get stuck in. Let's do some housekeeping
and tidy up this balance sheet by adding some totals.
On the left. We have total assets
and on the right we have total liabilities and equity.
These have to match each other exactly because the balance sheet always has to balance.
To emphasise this I'm going to add a little ‘balance checker’
that'll take the difference between these two cells.
This should always be equal to zero. Now that we've built a template
for our balance sheet it's time for some numbers.
Let's go back to the scenario of the window cleaning business
that we covered in the videos on T Accounts,
Journal Entries, and the Trial Balance.
I'll drop links to all of these down in the description.
We're going to use these transactions again so that you can see
how all of these concepts fit together. In the interest of saving you time.
I'm going to move through these transactions fairly quickly.
So if you find yourself getting stuck and wanting some deeper explanations
of the debits and credits, then go back and watch those videos
on T Accounts and Journal Entries. By the way,
on a side note… The Trial Balance is not
the same thing as the balance sheet. If you'd like to see me make a video
explaining the differences let me know in the comments.
There are six transactions that we're going to cover
and we'll work through them one by one filling out our balance sheet template as
we go. In transaction number one
The owner of the window cleaning business makes capital contributions of $100.
We're double entry bookkeeping so this transaction is going to affect
two accounts… Cash and owner's equity.
The business's cash is going to be debited to increase it by $100
and owner's equity will be credited to increase that by $100 as well.
Are we in balance? Yes we are.
In transaction number two the business takes out a further $200 loan
to fund this activities. We need to debit cash again by $200
to increase it and credit long-term loans by $200
to increase them too. Transaction 3.
The business spends 30 dollars in cash on window cleaning equipment.
We credit cash by 30 dollars to decrease it and we debit our plant, property and equipment
by 30 dollars to increase our equipment. In transaction four
the business spends a further $50 on cleaning supplies.
The payment is made on account. Paying for something on account
means that you're agreeing to pay the supplier at a later date.
So we debit our supplies by $50 to increase them.
And this time, we don't credit cash.
We credit accounts payable by $50 to increase them instead.
Just a couple more transactions left to go you've got this!
These ones are going to affect our retained earnings account.
Remember that means our profit held for future use
and it links the balance sheet and the income statement together.
I'll show you how this works now. Transaction 5.
The window cleaning business makes a hundred and fifty dollars
cleaning windows and uses up half of its cleaning supplies
in the process. This transaction is a bit more tricky
than the ones we've covered up to this point because there are two parts to it.
Each with their own double entries. The first thing that we need to do is
recognise revenue earned. To do that,
we debit cash to increase it by a hundred and fifty dollars
and we also credit revenue to increase that by a hundred and fifty dollars.
But hold up… where does revenue go?
I can't see it anywhere in our balance sheet?
We're going to need to jot down an income statement
for our window cleaning business. An income statement is a
summary of our revenue earned and expenses incurred
over a period of time. So here we have revenue of
a hundred and fifty dollars. Almost there…
Next we need to record the second part of the transaction.
Half of our cleaning supplies were used up on this job.
So we can't recognise those as an asset anymore.
They now make up our cost of sales.
Which is a kind of expense and belongs in our income statement as well.
In the fourth transaction we spend $50 on cleaning supplies
so if we've used up half of them, then we need to credit supplies
by $25 to decrease them and debit cost of sales
in the income statement to increase our expenses by $25.
But our balance sheet still isn't in balance. How can that be?
We need to build a bridge between the profits in our income statement
and the retained earnings or profits held for future use
in the equity section of our balance sheet. So the hundred and twenty five dollars
of profit in our income statement now flows through the
retained earnings and balances our balance sheet.
One important thing to note… Retained earnings and profit for the year
don't normally match each other exactly like they're doing in this example.
That just happens to be the case because we don't have any
retained earnings from previous years and none of the profits had been
drawn out of the business. That being said,
the simplicity of this example is a great way to demonstrate
this link between the income statement and the balance sheet.
We'll see how that works one more time in transaction 6.
Where our window cleaning business incurs laundry costs of $20.
The payment is made in cash. So we need to credit cash by $20
to decrease it and debit laundry costs by $20
to increase them in the income statement.
Our profit of a hundred and five dollars rolls up into the retained earnings section
of our balance sheet giving us total assets of
four hundred and fifty five dollars and total liabilities plus equity
of four hundred and fifty five dollars as well.
And our balance sheet checker is showing zero.
Good stuff! How did you find that?
I didn't want to skip any steps in this balance sheet tutorial.
If you've got any questions let me know down below in the comments
or send me a direct message on instagram
@accountingstuff Hit this circle to subscribe
and keep up to date with all of the latest videos
and check out the accounting basics playlist over here to explore some of the ideas that
we just touched on in more detail. And good luck with those balance sheets!
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