UNDERSTANDING ACCOUNTING TALK 3: The Balance Sheet is the most important Financial Statement

The basic accounting equation:

Assets = Liabilities + Equity or Assets – Liabilities = Equity

when itemized; i.e., when the different kinds of assets are listed (e.g., cash in the bank or on hand, payments or cash still to be received, things to be sold, property, etc) and different kinds of liabilities are identified (e.g., money borrowed, supplies still to be paid, tax due, etc) and Equity is classified according to cash or property you started with and according to what has been earned after expenses –is what accountants call a Balance Sheet.

It is a Balance Sheet because it is common sense that the basic accounting equality always is, or has to hold, true. Assets are always balanced with regard to the sum of Liabilities & Equity. When they do not balance, immediately you know that any one or a combination of the following has happened: you have not listed or valued your assets (i.e., accounted for them) properly; you have not listed all your debts or items you still have to pay for; you have somehow shortchanged yourself by not putting down all the money or property you put in or started with.

Whether the Balance Sheet is a large corporation’s, or that of a small business, or your own personal financial condition, the principle is cast in stone, is the same and holds true for all cases –no exception.

In our accounting, why do we want to start with the Balance Sheet? Why not a listing of what has been earned and spent (an Income Statement)? Or, why not a listing of cash coming in and cash being paid out (a Cash Flow Statement)?

At the end of the day, the most important and relevant information we want to know is what does the business really amount to or what are we really worth. An Income Statement can only tell you the difference between what has been earned and what has been spent. It cannot tell you what you or your business is really worth. A Cash Flow Statement can only tell you how much cash you have or your business has. It cannot tell you the other items that add or bring value to your personal finances or to a corporation.

The basic use of an Income Statement or a Cash Flow Statement is to show or explain changes in the Balance Sheet. These cannot show Net Worth.