Every small business person that I have met would confidently reply “of course!” Yet, in almost all cases, I am able to show them that it is substantially wrong. How is this possible they ask and then tell me it comes right out of QuickBooks.
The answer is that OTHER statement–the Balance Sheet.
To understand this we must first take you back in history to 1494 when Luca Pacioli, a Franciscan friar and collaborator of Leonardo DaVinci, first published a detailed description of double entry accounting.
Most of my readers have heard of this but do not really understand what it means. Wikipedia defines this as “a system of bookkeeping so named because every entry to an account requires a corresponding and opposite entry to a different account.” For example, when you pay the rent bill, you impact both your cash (bank) account and rent expense.
What this means is that most of the time when transactions are recorded they impact both your income statement AND your balance sheet.
Here is what you need to look for on your balance sheet to make sure there are no large mistakes on your income statement. The following are common mistakes on your balance sheet that could have a huge impact:
- Accounts that have negative balances
- Accounts that are assigned to the wrong category or statement
- Accounts that are not reconciled to statements
- Missing or inaccurate accounts for loans
- Unrecorded assets like computers, furniture and equipment
While most accounting systems try hard to make it easy for the small business owner, using them without a basic understanding of accounting principles often results in bad books. When we are retained to fix these books, I often remind the business owner that “behind the pretty face lies an ugly accounting program!”
Even most bookkeepers do not pay attention to the balance sheet. Not only does this increase the fees by accountants to fix the problems but, more importantly, it means that the owners are relying on a P&L that is not correct and actually very misleading!