software consulting, custom reporting, financial resources

Articles:

Credit Card Transactions

Entering Fixed Assets as Journal Entries

Estimating

Estimating-At-A-Glance

Estimating, Project Management Overview

Paying Liabilities and Transfers Between Accounts

Payroll Overview

Profitability

Proposals

Profits - Strategies to Improve

Responsibility As A Motivator

Risk Management

Schedule Variance

Take Your Business to the Next Level

Teamwork As A Motivator

Time Management

Time Management Matrix

Timetable of Procedures

The Balance Sheet, Part 1

The Balance Sheet, Part 2

The Balance Sheet, Part 3

The Balance Sheet, Part 4

Training Saves Money

Value As A Motivator

Year-end Close

The Balance Sheet, Part 2

Balance Sheet Organization:

The Balance Sheet follows an organized manner. First, Assets are listed in order of liquidity: those that can be turned into cash most quickly are listed first.

Liabilities are then listed in the order due. Current liabilities (those to be paid over the next twelve months) are listed first, followed by long-term liabilities (those that will be paid over a period longer than one year).

On a Balance Sheet, the Total Assets will equal the Total Liabilities plus Owners Equity. Accounting texts often teach the “Balance Sheet Formula”:
A = L + E (Assets = Liabilities plus Equity).

Sample Balance Sheet

Balance Sheet At December 31, 2008

Current Assets

Checking 35,000
Accounts receivable 145,000
Prepaid expenses 6,000
Prepaid advances 3,000

Total Current Assets 189,000

Fixed Assets

Vehicles/equipment 135,000
Less Accumulated Depreciation -48,000

Net Fixed Assets 87,000

Total Assets 276,000

Liabilities

Current Liabilities
Accounts payable 95,000
Payroll taxes payable 21,000
Workers’ comp payable 15,000

Total Current Liabilities 131,000

Notes payable 45,000
Long-term liabilities 45,000

Total Liabilities 176,000

Equity

Owner’s equity 25,000
Owner’s draw -85,000
Net Income 160,000
Total Equity 100,000
Total Liabilities and Owners Equity 276,00

The Critical Numbers - the Current Ratio

The commonly used Current Ratio provides a quick measure of a company’s ability to have the cash needed to pay current bills (this cash availability is also called liquidity). The current ratio can be found this way:

Current Assets / Current Liabilities

Current Assets typically include all cash accounts, Accounts Receivable, Prepaid Expenses, and Inventory. Current Liabilities include Accounts Payable and any principal owed on other notes during the next twelve months.

The current ratio should always be at least 1:1. In other words, the company’s assets should never be less than the company’s liabilities. Healthy companies carry a current ratio of about $1.50 in assets to $1.00 in liabilities.
Let’s use the Balance Sheet on the previous page as an example. Total Current
Assets are $189,000, while total Current Liabilities are $131,000. This company’s current ratio is 1.44, indicating a healthy financial situation.
Typically, the higher the company’s current ratio, the better. However, an unusually high current ratio can be comprised of a large receivable balance that may not be collectable. As companies grow, so does their Accounts Receivable, and they often find they do not have the cash needed for operations. In this instance, it’s helpful to obtain a Line of Credit. Although experts do not agree on the exact amount of credit that should be available to the company’s company, the common wisdom says that the available credit line should be equal to or greater than:

Approximately 3 months sum of average Accounts Receivable balance, or approximately 10 percent of total revenues. Other ratios can measure the company’s liquidity, profitability, and leverage. These use both the Income Statement and the Balance Sheet.

Special Issues

Prepaid Liability and Other Prepaid Accounts

Liability insurance has skyrocketed in the past few years. Not only is it difficult to find a company that will provide the insurance, but the costs to the company can be enormous. How the company handle liability insurance on the company’s Balance Sheet and the company’s Income Statement is important. If is not accounted for properly, the company will receive misleading information regarding the company’s profitability throughout the year.

Because of the matching principle discussed earlier, the company needs to recognize the cost of the company’s liability insurance equally over the course of the company’s policy.

For example, in a typical liability policy, the company pays a large portion as a down payment (usually 20 to 25 percent of the total contract amount), and then pays off the remainder of the policy in nine equal payments. Does this mean that the company’s insurance expenses are high the month the company pay the down payment and the first installment, much less in the next eight months, and free the last three months?

No. But if each payment is coded as an expense to the company’s Income Statement at the time the payment is made, the company will show an unusually large insurance expense during the first month when the company made the down payment, significantly reducing the company’s profit that month. Then, each successive month, the company will show a modest amount of liability insurance. However, during the last three months when the company has no payments, the company will have no insurance expense, making the company’s business appear more profitable during those months.

In order to equalize the insurance cost on each month’s financial statement, the company will need to code all payments for liability insurance to a Balance Sheet account such as Prepaid Liability Insurance. This includes the down payment and all subsequent payments. Then, each month the company must expense 1/12 of the total policy amount to the company’s Income Statement. The company can do this through an adjustment, such as a journal entry, or as a burden to the company’s payroll.

However the company does this, the goal is to show the cost of the company’s liability insurance equally over the life of the policy. This will give the company a more accurate view of the company’s profitability when looking at the company’s Income Statement each month. This can be true of any other expenses that cover several months or even several years. Does the company have annual maintenance contracts, separate automobile insurance, significant annual dues, or annual advertising costs? If any of these annual charges would significantly impact the company’s financial statements at the time of payment, the company may want to put the cost in a Prepaid Asset account and spread the expense over the contract’s life.

In the next installment of the discussion of the Balance Sheet, we’ll see how the matching principle applies in detail, and learn how to implement correct monthly accounting using the Work In Progress report in Master Builder.

Please contact me if you would like to learn more about instituting a comprehensive training process. Thank you.

Andy King
T: 805-771-8400
service@missiondevelopment.com