The Balance Sheet - Part 1 - A Comparative Net Worth Statement
(It's actually easy to understand if you ignore everything they ever said about it)
The Balance Sheet is in fact a "Comparative Net Worth Statement".
Do you know what "Net Worth is?"
Do you realize there are two ways to calculate it?
This Balance sheet has more resolution than any balance sheet you will find in other software or text books.
Typically two sub-reports are used to populate portions of the Balance Sheet. Those sub-reports hide the fact that a start date is required to complete a balance Sheet.
The also make it very difficult to get a full cognitive picture of all the Balance Sheet inputs.
For most in small business, this is a paradigm shifting way to view all relevant balance sheet data in a transparent and stress relieving way.
Net Worth
If you got hit by a bus today and died, how much would your family have left when your assets (things you have of value) are sold off and any debts you have (things you owe to others) are paid off.
That is your "Net Worth".
I own a car. The Car is worth $5000. I owe $3000 on it. I have nothing else of value. My clothes are even worthless.
What is my net worth?
$2000 >> ($5000-$3000)
$2000 is what my heirs would get if I got hit by a bus with these "assets" and "liabilities" in my name. This is "Net Worth".
If my clothes could have been sold for $100 at my time of death my net worth would have been $2100.
Comparative Net Worth
A "Comparative Net Worth" statement, calculates Net Worth two different ways.
The Incremental Method
The Absolute Method
The "incremental method" uses a starting networth on a given date, it adds in all transactions that would affect my net worth thru an end date and then provides the resulting net worth value for the end date.
The "absolute" method" simple uses a sum of my assets - a sum of my liabilties on a given date. The death by bus example above is an example of an "absolute" method analysis of my net worth.
Comparing the results of the "incremental method" to the results of the "absolute method" crosschecks the validity of the transactions that were used in the incremental method, which in fact is cross checking your bookkeeping process. This is more encompassing accuracy cross check as is performed in "statement reconciliation" which is performed in Step 1 of the 4 Step Bookkeeping Process.
1) Net Worth - The Incremental Method
In the Incremental Method, a known beginning net worth is written down for a given date.
Imagine that was $2000. This can be gleaned from my assets - liabilities at that point in time.
Then some time passes.
During that time, three paychecks totaling $900 are added to your checking account and your rent of $400 had to be paid.
At the end of this time period, your net worth would be $2500 ( $2000 + $900 - $400 ).
2) Net Worth - The Absolute Method
The absolute method is easier to calculate than the Incremental Method. You don't have to start with any value and you dont' have to track time. Questions are asked about your assets and liabiilties on a given day to get your net worth.
What do you have for Assets? I have a car worth $5000 and i have $500 in cash.
What do you have for Liabilities? I owe $3000 on my car.
Your Net Worth is $2500 (4900+500-3000)
This is not a circular process...
You might feel a little like you re going in circles here, because it seems like these two numbers should always come out the same?
Yes.
Exactly. They should. And they will as long as you don't make any categorization errors.
HOWEVER. You can and will make categorization errors that this report can help identify.
What if you forgot to categorize the $400 rent payment? If it is in the software, but without a categorization it will not show up in the Balance Sheet report on the Incremental Side because the software did not know where to put it.
The easiest way to see how a Balance Sheet can help you is to look at one a little deeper and then use software that allows you to change input values to see the errors appear and disappear in real time.