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. [Music] 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! [Music]