Where the Profit and Loss is a performance report over time, the Balance Sheet is a snapshot of your business’ net worth at one date.

There are several important ratios used to measure business health that pull data from the balance sheet, but I think the most valuable thing a business owner can do  with this report is to review it and make sure the numbers look right. If there are numbers on the balance sheet that look off or that you don’t understand, ask questions of your bookkeeper or accountant until you do understand them.

Errors on the balance sheet are usually offset by errors in the profit and loss, so catching errors on the balance sheet will help you fix the profit and loss. This is important in understanding how well your business is performing, and may save you on taxes if your profit and loss is erroneously showing too high a net income, and that’s the report your tax preparer uses to prepare your tax return.

Let’s review the sections of the balance sheet.

There are 3 main sections—Assets (what you own), Liabilities (what you owe), and Equity (your investment in the business. The basic balance sheet equation is Assets= Liabilities + Equity.

Each section can be further broken down. QuickBooks will give you asset sections for bank accounts, accounts receivable, other current assets, fixed assets, and other long-term assets, for example. Liabilities can be broken into Accounts Payable, Payroll Liabilities, Sales Tax Payable, and Loans Payable. The equity section will reflect owner investment (money or other assets the owner put into the business), owner draw (money or other assets the owner took out), current year net income, and retained earnings (earnings from previous years).

Balance sheet accounts should be reconciled regularly, meaning that the balance in the accounts should match up with supporting documents like bank, loan, and credit card statements. If there are differences (like uncleared checks), they should be listed and explained on the reconciliation report. Owners should review these reconciliation reports and understand them.

This is an important step not only to ensure the books are accurate, but can also be used to catch fraud or theft, which unfortunately does happen.

A few things to look for:

-Unreasonable or negative bank or credit card balances

-Old accounts receivable or accounts payable on the aging reports

-Any accounts you don’t understand (get an explanation!)

A common problem I often see is that a business owner will prepare invoices for their customers, and when they are paid, will record a payment that goes into an account named “Undeposited Funds”. This is like the drawer you put checks in before you take them into the bank. When they are deposited, you would use the “Make Deposit” feature to group those payments into a deposit that matches the amount that is actually deposited in the account. When the bank activity is downloaded, the downloaded transaction should match the deposit that was recorded in QuickBooks.

But what often happens to someone who doesn’t understand how this works is that the deposits never get recorded in QuickBooks, and the downloaded deposit gets booked directly to Sales.

When the payment was recorded in QuickBooks, the paid invoice is now part of the Sales figure if you are on the cash basis. If you’re on the accrual basis, it was recorded when the invoice was generated. In either case, if the deposit gets booked to Sales, you now have double reported that sale on the Profit and Loss. You can catch this on the balance sheet if there is a large figure in the account called “Undeposited Funds”, and you can’t figure out where all that income came from that is shown on the Profit and Loss.

There are a lot of errors that can be caught by reviewing the balance sheet—this is just one of the more common ones.

If the balance sheet is accurate, you can help your business by reviewing your accounts receivable figure and making sure invoices are being paid on time. Review credit card and loan balances to make sure they are manageable and you aren’t paying too much in interest charges.

Reviewing your financial statements may not be the most exciting way to spend your time, but improving your profitability by understanding and using the information contained in them is pretty exhiliarating!