How The BALANCE SHEET Works (Statement of Financial Position / SOFP)

this video is going to give you a solid introduction to the balance sheet in accounting I'm going to explain what it is how it's all laid out and then we're going to build ourselves a balance sheet from scratch using Google sheets and six example transactions hello there welcome back to the channel I'm James this is accounting stuff and in this tutorial we're going to cover the balance sheet in accounting the balance sheet or statement of financial position is one of the three major financial statements along with the income statement and cash flow statement so this is a big big topic if you run a startup then you absolutely must be able to prepare one of these in order to have a hope of getting funding and on the flip side if you're ever planning on learning money too or investing in a business then it's critical that you know how to read and understand the balance sheet because the balance sheet will give you an impression of the business's financial health and that will determine how risky the opportunity is for you and finally if you're an accountant then chances are you'll be hoping prepare one of these at the end of every accounting period over the past few months I've been posting weekly videos teaching accounting basics for beginners that you can find up here this video is going to link a bunch of these ideas together so if you find any parts of this explanation confusing then I recommend you check those out to cement your understanding and come back to this one if you need to there will be links in the description below to all of the relevant ones so feel free to check those out as I mentioned I'll be releasing new videos each week and I ain't cover all of the major parts of the balance sheet so hit the subscribe button and click on the Bell to be notified when those come out don't know about you but I'm itching to get cracking I mean what is the balance sheet let's find out the balance sheet looks like this the way it's presented can vary but there are some key elements at the core of the balance sheet that the rest of its built around here we have a balance sheet for a business called Craig's design and landscaping services that's because I tore this one from the sample company in QuickBooks Online quit books online is the biggest cloud accounting platform in the world and they specialize in small to medium size businesses so I thought this one would make a good example if you're thinking this all looks a bit crazy there no worries I'm only showing you the product will piece together a simpler one of these for ourselves in a moment right I think it's time for a definition a balance sheet is a snapshot of a business's assets liabilities and equity at a single point in time and that's exactly what we're looking at we have assets over here on the left and on the right hand side we have liabilities and equity beneath both of the headers we have all of the detail all of the individual groups of accounts summarized with their closing balances and the bottom of the balance sheet we have our total assets and total liabilities plus equity you'll notice that both of these numbers are exactly the same that's what we want to see is the aim of the game here because the balance sheet as suggested by its name always has to balance so your total assets must be equal to your total liabilities plus equity if they don't match each other exactly then we've got a problem in the past people used to make their balance sheets manually and this was a pain in the you could easily waste hours or even days trying to figure out where the errors were in your workings but thankfully nowadays the counting platforms like quickbooks online exist they ensure that your balance sheet always stays balanced if you run a small business and you'd like to give QuickBooks Online a try then you'd be doing me a massive favor if you follow my link down in the description it's an affiliate link so you'll get access to a free 30-day trial and the chance to support me making more accounting videos just like this one check out the video I made up here if you're interested but if cloud accounting isn't whew that's ok you can also support the channel by giving this video a like and sharing it with someone if you think they'd find it useful but anyway I promise you that we'd build ourselves a barn cheat from scratch and I meant it so here we are we have a clean slate we're going to build this balance sheet from the ground up using one key principle double-entry accounting in double-entry accounting every accounting entry has an opposite corresponding entry in a different count or put simply stuff the business owns is equal to the stuff the business owes we accountants course stuff there the business owns assets but the stuff that the business owes is a little bit more complicated we use two different words to describe it depending on who the biz yes Oh stuff too when a business Oh stuff to third parties like lenders suppliers and employees we call them liabilities however when a business Oh stuff to its owners we call it equity so we have assets are equal to liabilities plus equity this is the basic accounting equation and it always balances total assets must be equal to total liabilities plus equity now every financial transaction that a business is involved in affects this accounting equation so the values of our assets liabilities and equity are constantly changing but it's possible for us to take a snapshot and freeze their values at a single point in time when we do that we're looking at a balance sheet the thing is though that these three buckets are far too broad there are many types of assets liabilities and equity and it would be helpful if we could distinguish between them it's time for us to hop into Google sheets and flesh out this balance sheet we'll begin with assets and FY I'm going to move through this next section fairly quickly because I've made a video covering assets and a lot more detail that you can find linked up here and down below in the description the same goes for liabilities and equity so check those out if you'd like some fuller explanations assets are broken down broadly into two main categories current assets and non current assets current assets are short-term assets that can be converted into cash within one year some of the most common types of current assets are cash accounts receivable supplies inventory and prepaid expenses on the other hand non current assets are long-term assets that are used in operations to generate profit they can't easily be converted into cash so we expect to hold on to them for more than one year two common types of non current asset are long-term investments and property plant and equipment it's a similar situation for liabilities we have current liabilities which are our businesses obligations that need to be settled within one year from now these include accounts payable salaries payable taxes payable and accrued expenses and we also have non current liabilities obligations that aren't expected to be settled within one year stuff like long term loans and that leaves us with equity the final piece of the puzzle this section works a bit differently to assets and liabilities we have two broad categories to consider owner's equity and retained earnings you can think of retained earnings as profits held for future use and this is key because as the profit in retained earnings that forms the link between the balance sheet and the income statement keep that in mind or demonstrate how it works in this next example but before we get stuck in let's do some housekeeping and tidy up this balance sheets by adding some totals on the Left we have total assets and on the right we have total liabilities and equity these have to match each other exactly because the balance sheet always has to balance to emphasize this I'm going to add a little balance checker that'll take the difference between these two cells this should always be equal to zero now that we've built a template for our balance sheet it's time for some numbers let's go back to the scenario of the window cleaning business that we covered in the videos on t accounts journal entries and the trial balance I'll drop links to all of these down in the description we're going to use these transactions again so that you can see how all of these concepts fit together in the interest of saving you time I'm going to move through these transactions fairly quickly so if you find yourself getting stuck and wanting some deeper explanations of the debits and credits then go back and watch those videos on T accounts and journal entries by the way in a side note the trial balance is not the same thing as the balance sheet if you'd like to see me make a video explaining the differences let me know in the comments there are six transactions that we're going to cover and we'll work through them one by one filling out our balance sheet templates as we go in transaction number one the owner of the window cleaning business makes capital contributions of $100 we're double entry bookkeeping so this transaction is going to effect two accounts cash and owner's equity the business's cash is going to be debited to increase it by $100 an owner's equity will be credited to increase that by $100 as well are we in balance yes we are in transaction number two the business takes out a further $200 loan to fund this activity we need to debit cash again by $200 to increase it and credit long-term loans by $200 to increase them to transaction 3 the business spends 30 dollars in cash on window cleaning equipment we credit cash by 30 dollars to decrease it and we debit our pond property and equipment by 30 dollars to increase our equipment in transaction for the business spends a further $50 on cleaning supplies the payment is made on account paying for something on account means that you're agreeing to pay the supplier at a later date so we debit our supplies by $50 to increase them and this time we don't credit cash we credit accounts payable by $50 to increase them instead just a couple more transactions left to go you've got this these ones are going to affect our retained earnings account remember that means our profit held for future use and it links the balance sheet and the income statement together I'll show you how this works now transaction 5 the window cleaning business makes a hundred and fifty dollars cleaning windows and uses up half of its cleaning supplies in the process this transaction is a bit more tricky than the ones we've covered up to this point because there are two parts to it each with their own double entries the first thing that we need to do is recognize revenue earned to do that we debit cash to increase it by a hundred and fifty dollars and we also credit revenue to increase that by a hundred and fifty dollars behold up where does revenue go I can't see it anywhere in our balance sheet we're going to need to jot down an income statement for our window cleaning business an income statement is a summary of our revenue earned and expenses incurred over a period of time so here we have revenue of a hundred and fifty dollars almost there next we need to record the second part of the transaction half of our cleaning supplies were used up on this job so we can't recognize those as an asset anymore they now make up our cost of sales which is a kind of expense and belongs in our income statement as well in the fourth transaction we spend $50 on cleaning supplies so if we've used up half of them that we need to credit supplies by $25 to decrease them and debit cost of sales in the income statement to increase our expenses by $25.00 but our balance sheet still isn't in balance how can that be we need to build a bridge between the profits in our income statement and the retained earnings or profits help future use in the equity section of our balance sheet so the hundred and twenty five dollars of profits in our income statement now flows through the retained earnings and bounces our balance sheet one important thing to note retained earnings and profit for the year don't normally match each other exactly like they're doing this example that just happens to be the case because we don't have any retained earnings from previous years and none of the profits had been drawn out of the business that being said the simplicity of this example is a great way to demonstrate this link between the income statement and the balance sheet we'll see how that works one more time in transaction 6 where our window cleaning business incurs laundry costs of $20 the payment is made in cash so we need to credit cash by $20 to decrease it and debits laundry costs by $20 to increase them in the income statement our profit of a hundred and five dollars rolls up into the retained earnings section of our balance sheet giving us total assets of four hundred and fifty five dollars and total liabilities plus equity of four hundred and fifty five dollars as well and our balance sheet checker is showing zero good stuff how did you find that I didn't want to skip any steps in this balance sheet tutorial if you've got any questions let me know down below in the comments or send me a direct message on instagram at accounting stuff hit this circle to subscribe and keep up to date with all of the latest videos and check how the accounting basics playlist over here to explore some of the ideas that we just touched on in more detail and go like with those balance sheets [Music]

Channel: Accounting Stuff

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Keywords: balance sheet accounting, balance sheet explained, balance sheet, accounting, statement of financial position, balance sheet tutorial, accounting tutorial, quickbooks online, how to make a balance sheet, financial statements, accounting 101, accounting basics, statement of financial position explained, statement of financial position tutorial, assets, liabilities, equity, accounting equation, accounting for beginners, what is balance sheet, balance sheet google sheets

Id: YZyBSU6YdmM

Length: 12min 47sec (767 seconds)

Published: Tue May 14 2019