The Liabilities side of your Balance Sheet

Assets = Liabilities + Owners Equity. Assets – Liabilities = Owners Equity

The Liabilities side of your balance sheet has two parts: current liabilities and long-term liabilities.

Current liabilities are ones that have to be paid within twelve months. They include accounts payable, taxes payable, customer deposits, accrued expenses and short-term notes payable.

Customer deposits are a liability because the client gave you money that you deposited, but you didn’t deliver the goods or service yet. You “owe” them.

Accrued Expenses are expenses that you know you incurred in that period, but you didn’t get the bill for, or pay yet. For example, let’s say the month or year ends on a Thursday, and the pay week ends on a Friday. You have four days of payroll expense that was incurred in one month but will be paid in the next month. So you accrue four days’ worth of payroll under “accrued expenses.”

The idea is to line up the big expenses and the revenue that was billed in the correct month. You don’t have to accrue little expenses and you may not accrue expenses monthly, but just at year end, but the idea is to get it as close as possible when it counts.

Also under Current Liabilities, you have short-term notes payable. These are loans you have to pay back within twelve months, which may include credit cards and short-term credit lines.

More tomorrow!

Depreciation

Depreciation is the accounting method of allocating the cost of an asset over its useful life. Most fixed assets, with the exception of land that buildings are on, are depreciable assets.

Accountants like to count expenses against the revenue for the same period. So, if you billed for $100,000 worth of work in a month, and had expenses associated with delivering that work of $85,000 that month, you can figure what your profit was. 

But what messes them up is when you buy something that lasts a long time, like a vehicle, or a new computer system. It’s an expense, yes, but the benefit will last a long time – let’s say 5 years (60 months). So the accountant will take 1/60th of the expense of the vehicle each month for 5 years. That’s called depreciation.

So this is how it works. When you buy that vehicle, it will not show on your Income Statement (P&L) for the month. Instead, it goes on the Balance Sheet as an asset for the full value of what you paid for it. If you took out a loan to buy the vehicle, the amount of the loan goes on your Balance Sheet as a liability.

Each month, your accountant will subtract 1/60th of the value from the asset section of the Balance Sheet, not by reducing the value of the asset, but by creating a line called “Accumulated Depreciation,” which would be a (negative number) under the value of your assets. 

So let’s say the vehicle cost $60,000. Each month your accountant will depreciate $1,000 of the truck. So after 10 months, the Balance Sheet shows $60,000 for the value of the truck, and ($10,000) of accumulated depreciation, with a net value of $50,000. You see, the truck is older now and not worth as much. Of course, it doesn’t show a line item for each asset you are depreciating – it just shows the value of all the accumulated depreciation you have taken on all assets listed. 

Let’s say you own the vehicle for 6 years and depreciated it over five years. After 60 months it is fully depreciated. What does that mean? It means the value of the asset will show on your Balance Sheet as $60,000 (the price you paid for it 6 years ago) and the Balance Sheet will also show $60,000 of “Accumulated Depreciation” as a negative number in your asset column – effectively making the value of the asset on your Balance Sheet zero. 

The truck stays on your Balance Sheet that way forever until you sell it or get rid of it. Let’s say you junk the vehicle in year 8. You remove $60,000 worth of assets and $60,000 of accumulated depreciation from your Balance Sheet.

That’s what is happening on the Balance Sheet. 

On the monthly Income Statement, the expense for the truck never showed in the month you bought it. Instead, your accountant will add a $1,000 expense each month for “depreciation” of that truck. In other words, you “used up” 1/60th of that truck that month, so we are taking an expense for it that month.

Different assets are depreciated for different periods of time. Buildings (not the land they are on): 39 years. Computers and trucks: 5 years. Equipment and Machinery: 5, 7 or 10 years. Furniture, 5-7 years. If I remodel my office or re-roof my building: 7, 10 or 15 years depending on how long these things are expected to last.

It’s important to note that depreciation for accounting purposes is different than depreciation for tax purposes. Tax law may allow you to expense fixed assets faster or all in the same year. Consult your tax professional.

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The asset section of your Balance Sheet

The Balance Sheet shows the financial performance of the company since inception, unlike an Income Statement which starts over every year.  It has things on it the Income Statement doesn’t, like Payables and Receivables.

There are 3 parts to a Balance Sheet: Assets, Liabilities and Owners Equity.

The Assets section is made up of Current Assets and Fixed Assets.

Current Assets are things that can be converted into cash within a year and include cash, receivables, inventory and pre-paid expenses. 

Fixed Assets are investments you have made in things that last a long time that you use to run your business, and are not things that you sell in the operation of your company.  They include things like vehicles, tools and equipment, computers, furniture and fixtures, and leasehold improvements.

More tomorrow!

Assets = Liabilities + Owners Equity

Why do they call it a “Balance Sheet”?  Because the two sides, Assets on the left (top) and Liabilities and Owners Equity (on the bottom or right) equal each other.

Assets = Liabilities + Owners Equity

Let’s say PDQ Services has $200,000 in assets, which includes cash, receivables, vehicles, equipment and inventory. And let’s say they have $80,000 in liabilities, which include payables and loans outstanding. Their Equity is $120,000. 

Assets of $200,000 = Liabilities of $80,000 + Equity of $120,000.

Another way to express it is Assets – Liabilities = Owners Equity.

More tomorrow!

The Balance Sheet

The Balance shows a business’s financial situation at a moment in time.  It is a statement of assets, liabilities and capital of a business.

An Income Statement (P&L) shows the net profit or loss for the previous period (month, year to date, or year).  The Balance Sheet is different.  The performance of the business since inception is accumulated on the Balance Sheet. 

The Balance Sheet has three sections – Assets, Liabilities and Owners Equity.

More tomorrow!

The Income Statement

The Income Statement (aka “Profit and Loss Statement”) goes on to show “General and Administrative Expenses,” sometimes called “overhead.” These are both variable and fixed expenses that you’d have to pay even if you didn’t sell anything in that period. They are “indirect,” meaning you can’t attribute them directly to any one sale.

When you subtract G&A expenses from Gross Profit, you get EBIT – Earnings Before Interest, Taxes and Depreciation. Some businesses may call it “Operating Profit.”

There will be a section called “Other Income and Expenses” toward the bottom of your income statement. There you will see interest expense, and very importantly, depreciation. Depreciation is a non-cash expense of a piece of your purchases of capital investments. Things you buy such as vehicles, equipment, buildings, computers, and improvements to your facility that last a long time and are used to run your business, are depreciable.

Once you deduct depreciation and interest, you get the net profit – or loss. That’s at the bottom of your Income Statement.

Accounting week!

Be the change

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Dress for the person you want to be, not the person you are.

Your life goes where your eyes go

Your life goes where your eyes go, because that’s what you’ll be thinking about and ultimately take action on.

What (who) are you looking at? What are you watching or reading? What environment are you in?

Your life goes where your eyes go.

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The more you learn, the more you can earn. The more you learn, the better decisions you will make, the fewer mistakes you will make, and the more people will follow you.

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