In order to do this, our balance sheet displays the difference between a business’s assets and liabilities. This difference is known as the business’s net assets and is considered to be the “value” of the business. Obviously, every successful business owner wants to amass the highest amount of net assets as possible!
How to Prepare a Balance Sheet from Trial Balance
To create our balance sheet, we’re going to need the remaining sections of our Trial Balance – Assets, Liabilities, Owners Equity, and Drawings. Take a quick look at those. Let’s take a look at these numbers: Assets
Bank $24,150 Computer $1,500 Car $3,000
Liabilities
Loan $9,000 Johns Car Shop $3,000 Taxation Payable $675 Accumulated Depreciation $400
Owners’ Equity
Owners Equity $15,000 Drawings $1,000
We’ll also need to know our net profit for the year, which we know from our Profit and Loss statement, which is $1,575. Alright, that’s all the information we need. Let’s get started. The basic format of a Balance Sheet is:
Assets – Liabilities = Owners Equity (Net Assets)
Using the figures from our Trial Balance, simply fill in the blanks on the Balance Sheet below. Note that there are two formats, a “T” format and a list format. Both formats are commonly used, and are simply different methods of displaying the same information. GREAT! We’ve just completed our Balance Sheet.
How to Read a Balance Sheet
Let me point out a few interesting things about it.
Notice how the Owner’s Equity at the top of the statement balances with the Net Assets at the bottom of the statement. They’re both $15,575. This is where the term Balance Sheet comes from. If your Balance Sheet doesn’t balance, you’ve got a problem!
Notice how your Owner’s Equity changed. It’s now $15,575, even though you’ve only put $15,000 into the business, which was the original amount. This is because you made a profit. As the owner, this profit is yours! Each year, any profit you make will carry over to the Owner’s Equity section of the Balance Sheet. If you’ve been in business for ten years, then ten years of profit will have been accumulated in your Owner’s Equity. Think of Owner’s Equity as the amount the business owes to you, so whenever you make a profit, it’s yours! Oh, the joys of being a business owner!
Your Owner’s Equity only increased by $575, even though you made $1,575 in profit. Why is that? It’s because you took $1,000 of drawings during the year. That means although the $2,250 profit is yours, you already took $1,000 of it. Owners need to be careful not to withdraw so much in drawings that their Owner’s Equity falls below zero. That’s it friends! We’ve started our business, recorded all our transactions, prepared a list of journal entries, entered them into our ledgers, taken our ledger balances into a trial balance, and finally produced a Profit and Loss Statement and a Balance Sheet!
This is the accounting process in action, and we now have two key reports that provide valuable information and will allow us to make good financial decisions. We’ll talk a bit about that in a later tutorial.
