Balance Sheet

Cash Basis Approach

Perhaps the most difficult financial statement to forecast and prepare is the Balance Sheet. The Balance Sheet is challenging because it has multiple general ledger accounts (Cash, Inventory, Fixed Assets, and various liability and equity accounts) all subject to changing balances throughout the year.

At the same time, everything has to be in balance – all entries balance between debits and credits and the sum of all assets must balance to the sum of liabilities + equity. Additionally, some transactions will hit the Balance Sheet on one side only – the other side of the entry hits the Income Statement. For example, operating expenses are paid out of cash (credit entry), but the debit side hits the Income Statement as Operating Expenses.

Since most transactions for a small business are cash basis, the best way to attack preparing the Balance Sheet is to think “cash basis” accounting and then at the end of the reporting cycle (usually year end December 31st), prepare some accrual entries which are mostly Accounts Receivable (money owed to the business) and Accounts Payable (money the business owes to others).

One way to simplify this process is to consolidate certain types of transactions into summarized entries. For example, your business has six (6) different operating expenses. Instead of posting six entries, post a consolidated entry Operating Expenses with the goal of arriving at the correct Cash Account balance. When you get to the Cash Flow Statement, you can list out all Operating Expenses. We can also consolidate all loan repayments and inventory restocking entries. Therefore, we can think of posting monthly cash entries as follows:

1. Decrease Cash by Sum of all Operating Expenses

2. Increase Cash by Sum of all Sales Revenues

3. Increase Cash by Sum of all Owner Contributions

4. Decrease Cash by Sum of all Debt Payments

5. Increase Cash by Sum of all Financing Transactions such as Loans

6. Decrease Cash by Sum of all Inventory Restocking Transactions

As you work through the monthly cash transactions, unpack the other side of the entry and make sure you have an offsetting general ledger account – Balance Sheet and/or Income Statement.

Another issue that you can run into is – cash balances grow to a large level. Most startup businesses will be hard pressed to grow and create lots of cash from sales. But in the event that your startup does grow and generate lots of cash, you need to think about re-investing the excess cash back into the business and / or distribute cash back to the equity investors.

By focusing on the cash account from the start of the year to the end of the year not only does this make preparing the Balance Sheet easier, but it also prepares the structure for the Cash Flow Statement. We essentially knock out two financial statements with this Cash Basis approach.

The key here is to check your cash balances month to month and make sure you have positive balances. What happens if the monthly cash balance becomes negative? Then go back to the Funding Plan and make revisions to infuse more funds into the business to cover cash shortfalls. This is part of the process of building a solid integrated financial forecast. You need to cover your expenses with funding until customer sales becomes the main source of cash inflows.

Post All Entries through Cash

Start off with a $ - 0 – (zero) balance in cash for the business and funds come from two sources: Owner and Family (Stage 1 – Financing). Then a series of cash transactions takes place to make important one time investments in assets (Stage 2 – Investments). This moves us to the third stage of cash flow – Operations where we start to capture customers, have sales and pay recurring operating expenses.

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Beginning Balances

If you are preparing a Balance Sheet for a business that has past historical transactions, then you need to construct your opening balances for all general accounts that comprise Assets, Liabilities and Equity. Do your best to reconstruct what you think these account balances are and the difference between the sum of Assets vs. the sum of Liabilities and Equity will get posted to Retained Earnings. Remember, total Assets must equal the sum of Liabilities + Equity; otherwise you cannot move forward with preparing the Balance Sheet.

Inventory Control

If your business sells products, then you will need to capture and track the movement of inventory during the calendar year. Inventory is a critical asset on the Balance Sheet for product related businesses. It requires a detail process of setting up all products with SKU – Stock Keeping Unit numbers, beginning quantity and unit cost. This is not an easy exercise and often software programs are needed to manage inventory.

If the unit cost for your inventory changes, then you need to follow a consistent approach on how you cost out your inventory. The costing out of inventory as it is sold is charged to Cost of Goods Sold and the unit cost applied depends upon the method followed by the business which is usually one of three approaches: FIFO – First In First Out, LIFO – Last In First Out or Weighted Average.

Example of Inventory Control

In order to properly cost of inventory as it is sold, you have to know what the unit cost of each item that you are selling. In the example below, the total unit cost of the product is $ 740 and as units are sold, inventory is reduced by the units sold. You have to also reduce the balance in the Inventory general ledger account. In the example below, we built up the inventory in April and May, with a balance going into June of 155 units. See example below:

Post Accrual Entries at End of Cycle

Receivables and Payables

How much money at year end would you expect outstanding Receivables and Payables to be based on your sales revenues billed out and your outstanding operating expenses that have not been paid yet. You not required to do accrual accounting as a startup, but if the business will grow and has plans to exceed $ 20 million in annual revenues, then you will be forced to follow accrual basis of accounting.

Depreciation and Amortization

How much accumulated depreciation and amortization should be accrued for fixed assets – tangible assets such as vehicles and equipment as well as intangible assets such as patents. This is the most common closing entry that everyone has to make; but it depends if you have assets on the books. Some startup businesses are strictly professional services with no assets.

Closing Entry

A final closing entry is made to close out the Income Statement to a special account in the Equity Section of the Balance Sheet – Retained Earnings. This creates a balance between all debit entries and all credit entries for the entire year across all five major types of accounts – Assets, Liabilities and Equity which comprise the Balance Sheet and Revenues and Expenses which comprise the Income Statement. Every reporting cycle is closed out to the Balance Sheet through a Retained Earnings account which accumulates all of the losses and profits of a business from inception.

Summarized Entries for the Year

To make sure you understand this process, let’s work through an example that summarizes the process down to lump sum entries for the entire year. The first set of transactions for a startup will be to fund the business with equity and possible debt for asset acquisitions

In our example, we are assuming no opening balances and this is the start of the bookkeeping cycle for all transactions. We have $ 130,000 in startup funding to launch the business. Next, we can summarize the basic entries for the entire year and make sure we are posting all offsetting entries from Cash to an appropriate general ledger account that hits the Balance Sheet and / or Income Statement

Startup Financial Plan

Startup Financial Plan

Preparing the Balance Sheet

Cash Basis Approach