How Do I Know If My Books Are Correct?

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How do I know if my books are correct
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The Balance Sheet
  • This is our starting point and probably the most important report for a business. It shows a snapshot of a business’s financial position. This helps you and others understand its overall condition.
  • If you are using accounting software, the Balance Sheet will always “balance” because nothing can be posted without an opposite entry. This is why it is called double entry bookkeeping.
  • A Balance Sheet that balances does not always mean it is correct!
Example Balance Sheet

Assets = (Liabilities + Equity)

Assets – (anything the company owns that holds value and can help generate income or support its operations.)

  • Current Assets – (held for a short time e.g. Cash, Stock)
  • Non – Current Assets – (held for a long-time e.g. Machinery)

Liabilities – (any financial obligation that the business has – e.g., payment of suppliers, payment of employees)

  • Current Liabilities – (repayable this year e.g. Supplier debts, bank overdraft)
  • Non – Current Assets – (repayable after 1 year e.g. Mortgage, loans)

Equity – (the owners share of the total value of a business I.e. The total assets)

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What to check on the balance sheet?

Now we have got to grips with what a balance sheet is and should look like, let’s consider what you should be checking to know if your books are correct.

Positive and negative numbers

  • The “Assets” section would normally have debit balances
  • The “Liabilities” and “Equity” section would normally have credit balances.

Current/non-current split.

  • Do a sense check on the split.
  • Do you have a loan that is repayable in 5 years’ time showing in the Current Assets?
  • Do you have a machine that is not for sale showing as part of your stock?

Values

Compare £ amounts on your balance sheet with external documents.

  • Do the bank balances match your bank statement?
  • Do the loan amounts match your loan agreement?
  • Does the VAT amount match the last VAT return? If not, is the difference just those transactions recorded since the last return?
  • Does your BS show you owe money to employees when you believe everyone has been paid?
  • Does the PAYE and NI liability amount on your BS match last month’s PAYE and NI amount as per the payroll report? Does it match the records on your HMRC account?
  • Does the value of the stock match the physical inspection stock take records?

Check what you owe to suppliers. This is in current liabilities, usually called “Trade Creditors”. You can run a report called “Aged Payables Report.”

  • Compare the aged payables report to what you expect/know has been paid.
    • Is there something showing on there that you always pay by direct debit or credit card? It’s a red flag if these are showing as outstanding.
    • Is there anything unusually old on there?
    • Compare balances with supplier statements to be sure.

Check what is owed to you from customers – This is in current assets usually called “Trade Debtors”. There is a detail of this called “Aged Receivables Report.”

  • Compare the Aged receivables report to what you expect/know has been paid.
The Income Statement (Profit and Loss)
  • This shows a business’s performance over a specific period. It highlights revenue, expenses, and profits (or losses) during that time.
  • A review of this will help you to see if your income is correct. It will also indicate if all your costs have been recorded and correctly categorized.
Example Income Statement

What to check on the Income Statement?

You will want to compare balances over a period of 6 months or more. This is called a “Variance analysis) and you’re looking for omissions and signs of duplications. Let’s work through some examples.

Check the sales make sense.

  • Just a quick glance here tells us sales are normally around £40K a month. April immediately looks like it could be incorrect and May looks unusually high.
  • Looking at the Gross profit margin indicates that an error has been made. April is negative and May is double the norm.
  • Both these red flags suggest that there has been an error made in the period when sales have been recorded.
    • Have some April sales invoices been dated in May incorrectly?
  • The negative £83 in Interest income stands out because no other months have a balance.
    • Glancing down further to Interest costs, there is a cost of £83 missing from the month of February. This suggest the interest expense was incorrectly posted to the interest income account.

Are any regular costs missing?

  • It looks like the insurance cost for March is missing so we need to investigate.
    • Has the March invoice been omitted? Or has the bookkeeper forgotten to release the prepayment that month?
  • Depreciation for June seems to be missing. It’s likely the journal for this month has not been posted or posted using an incorrect date.
  • IT expenses is double in April and NIL in May which suggests an invoice has been posted with an incorrect date or an accrual hasn’t been reversed.
  • Employers National Insurance is missing from April to June. Is there an explanation for this? If not, it could be an error. (in this case it is explained by the Employers allowance)

Are there any unusual costs?

  • On our example legal fees have only occurred in February. Is the reason for this known? If not, the bill should be checked.
  • As above, is there a reasonable explanation for higher-than-normal accountancy fees in May?

In conclusion, apply your knowledge of your own business and use common sense when looking at these two reports. You know your business better than anybody so you’ll know if your books are showing unexpected revenue or costs. If you’re still unsure, get an accountant to review your accounts.

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