A balance sheet shows a quick snapshot of the financial situation of a company at a particular time. An accountant reports on two distinct groups of activities that a business engages in. These are profit-making activities. This includes sales and expenses. These activities can also be called operating activities. These activities include financing and investing. They can be done from equity and debt sources.
Income statements report profit-making activities; the statement of cash flow reports financing and investing activities. Two financial statements are prepared to reflect the different types of transactions. Also, the statement of cash flow reports the cash increase/decrease from profit throughout the year. This is in contrast to the amount of profit reported in the income statement.
The balance sheet differs from income and cash flow statements, which report the income of cash and outgoing money. The balance sheet is a snapshot of the company’s assets, liabilities, and owner’s equity. There are many meanings of the word balance. The term balance, as it is used in the phrase balance sheet, refers to the sum of two sides of a business: total assets and total liabilities. The balance of an account (also known as an asset, liability, and revenue), refers to the amount in the account after accounting for increases and decreases. It is similar to your checking account balance. A manager may request a balance sheet. Accountants can prepare one at any time. They are usually prepared at the end of each month, quarter, and year. It is always prepared on the last day of the profit period.
Revenue and receivables
Sales and expenses are the main drivers of a business’s balance sheet. They are the main drivers of the business’s assets and liabilities. Accounts receivable is one of the most complicated accounting items. Imagine a business offering its customers a 30-day credit term. This is a common scenario in transactions between businesses (not between businesses and consumers).
An accounts receivable asset is a record of how much money customers who purchased products on credit still owe to the business. It is a promise that the business will get it. Accounts receivable simply refers to the uncollected sales revenue at end of an accounting period. Cash doesn’t increase until the company collects it from its customers. The total sales revenue for the same period includes the money in accounts receivable. Even though it has not yet received all of the revenue from sales, the business made the sales. The sales revenue is not equal to the cash the business has accumulated.
The accountant must subtract from the cash sales revenue the number of credit sales that were not collected to get the actual cash flow. Add the cash collected from credit sales in the previous reporting period. If the credit sales made by a business during the reporting period exceeds the amount collected from customers, the accounts receivable account will increase, and the business must subtract that amount from net income.
If they collect more than credit sales made during the reporting periods, the accounts receivables will decrease over that period. The accountant must add to net income the difference between receivables at the beginning and end of the reporting period.
Inventory and expenses
A business selling products usually have inventory as its largest current asset. If the inventory balance is higher at the end than at the beginning of the reporting period then the actual cash paid by the business for the inventory is less than the cost of good selling expense. The accountant subtracts the inventory increase from net profit to determine cash flow from profit when this happens.
The prepaid expenses asset account functions in the same manner as inventory and accounts receivable changes. Changes in prepaid expenses tend to be smaller than those in the other asset accounts.
Although the beginning balance of prepaid expenses will be charged as an expense for the current year, the cash was paid out in the previous year. During this period, the business pays cash to cover the next period’s pre-paid expenses. However, it doesn’t impact net income until the next period. Simple, right?
A business’s ability to grow will require it to increase its prepaid expenses. This includes fire insurance premiums and office supplies stocks. A business’s cash flow price for growth is determined by its inventory, accounts receivable and prepaid expenses. Rarely will you find a company that can increase its sales without increasing its assets?
Cash flow is the cost of business growth. Managers and investors must understand that growing sales without increasing receivables is not a realistic scenario for growth. You can’t grow revenue in real business without having to incur additional expenses.