Truthfully, almost every company struggles with finances. Some cannot keep a check-in balance of their inflows and outflows, whereas others lag with compliance. It might be challenging to keep track of money-related matters but not impossible. All you have to do is utilize financial modeling software and follow the guidelines set by International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS). These two regulatory bodies have highlighted everything a company needs to know about finances.
Talking about the primary points, every organization must maintain financial statements. That includes income statements, cash flows, statements of comprehensive income, and, most importantly, balance sheets. It is because the balance sheet unfolds the company’s financial position. It lists all assets, liabilities, and equity, showing where the business stands.
If assets outweigh liabilities or vice versa, the company must be recording something incorrectly. So let us show you the ropes if you have also lagged in this domain. Here we have listed five balance sheet mistakes that you must avoid.
1. Omission of Entries
Companies must collect invoices and receipts to determine how much money is coming in and going out of the business. And if they forget to record a single transaction, it disrupts the financial statements. Omitting transactions unbalances the figures and gives an inaccurate impression of the company’s finances. The only way out is to automate the bookkeeping process.
For instance, ASC 842 lease accounting standard requires corporations to recognize most leases on the balance sheet as right-of-use assets and lease liabilities. Perhaps, you can integrate software for ASC 842 accounting that will record all transactions and prepare financial statements. As all data gets recorded automatically, the chances of omission will be null. Therefore, all entries will be present in your trial balance, allowing you to prepare an accurate balance sheet.
Further, you must integrate the software with your business bank account. It will record all outflows and inflows, giving you the exact amount of cash at the bank for your balance sheet.
2. Incorrect Presentation
Have you seen a formal balance sheet? If yes, you must have observed a similar format. Every company has to adhere to a presentation format provided by IAS-1. However, small businesses aren’t aware. As a result, they end up putting all assets and liabilities together, which disrupts the balance sheet format.
According to IAS-1, the balance sheet must have an accurate and fair presentation. That means you should represent all assets, liabilities, and capital separately. Therefore, first, you have to mention assets – non-current and current. After that, you have to show the number of total assets as ‘assets = liabilities + capital.’ The following section will include your liabilities – current and non-current and equity. Your entire share capital, retained earnings, drawings, and net profit will come under equity.
Lastly, you must ensure that the sum of liabilities and equities matches total assets. In case of a mismatch, recalculate your numbers to reach the balancing amount.
3, Errors in Classification
At times, accountants cannot distinguish between assets, liabilities, and capital. As a result, they often record capital under their non-current assets. Likewise, many have registered their liabilities as current assets. Such errors in classification can have significant consequences for the business. It leads to overstatement and understatement of profit, giving an incorrect view of the company’s financial position. Therefore, accountants and bookkeepers must learn to classify every entry.
A non-current asset is an asset with a life of more than one year, such as plant, machinery, equipment, etc. These assets provide economic benefits and generate revenue for the company, whereas a non-current liability is a loan. The money you borrowed from an external source to finance the asset. Similarly, a current asset is an asset with a life of less than a year, such as cash in hand or bank. Eventually, you will spend the money over time, whereas a current liability is a short-term bill you owe to someone. It could also be the money you owe to suppliers.
Lastly, capital is the money you invest in the business, more like a one-time transaction. Therefore, classify every transaction wisely and fit it in the correct box.
4. Negating Inventory Changes
Not many people know, but inventory has a significant part in the balance sheet. It comes under the current asset section since leftover goods are a company’s asset. However, accountants don’t record inventory correctly. Some record it at its cost, whereas others record it at its selling price. Neither of the two approaches is correct, as inventory should be recorded at net realizable value (NRV). It is the least possible cost at which inventory can get sold.
Now, the purpose of using this cost is prudence. Accountancy runs on prudence, which states any potential loss must be in the books beforehand. Thus, if your inventory doesn’t sell at a price, you must sell it at NRV to mitigate losses. Likewise, you must record it on NRV in the balance sheet to account for all inventory changes.
5. Incorrect Balancing Figure
Mostly, companies are unable to balance figures in their balance sheet. Sometimes, the assets side is higher, whereas, at times, the liabilities seem more. As a result, they add a balance figure to balance the costs. Unfortunately, that is not according to the reporting standards. Unless the board of directors and shareholders approve, companies cannot add a balancing figure to the balance sheet. Therefore, you must find mistakes and balance assets with liabilities and equity.
Perhaps, you might have overstated the loan amount or excluded repayments in your balance sheet. Likewise, some companies don’t add intangible assets, i.e., Goodwill, that undervalues their assets. Remember, anything that classifies as an asset, liability, or equity should go in your balance sheet. Also, if you have taken any money for personal use from the business, deduct it from equity – drawings. It might help in correcting the balancing figure.
A company’s balance sheet is full of little yet impactful details. For example, it shows how much a business is worth and its dependence on debt. At the same time, it showcases the profit company has made during the year. Thus, shareholders can get an overall idea of the business only by looking at its balance sheet. As this financial statement is crucial, a business must ensure it is error-free. So get familiar with accounting standards and implement the right tools to streamline accuracy.
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