There are many lenses businesses use to understand their financial health at a glance. One such lens is account balances, which can be easily found on the balance sheet.
You may know the term with regards to bank accounts, but it goes beyond that.
Here’s what you need to know to get started tracking account balances and getting a better understanding of where your business is headed.
What is an account balance?
An account balance is how much money is the net money present in a financial account at the end of an accounting period. To find an account balance, you look at the aptly named balance sheet.
The account balance is measured by what is owned and what is owed. What determines this is whether the account is an asset or liability.
Assets are what a business owns, therefore the account balance measures what the business owns in the asset accounts such as bank accounts, digital wallets, and cash on hand.
Liabilities are what a business owes, therefore the account balance is the remaining debt that needs to be paid by the business for credit cards, loans, or lines of credit as examples.
Importance of tracking account balances
Since account balances represent how much cash a business has available to them and how much is owed, they are one the main barometers used to measure financial health.
If the account balances of the assets is greater than the account balances of the liabilities, the business has enough value to cover its debts with cash left over.
But if the opposite is true and more is owed than owned, the business is at risk of insolvency, an inability to pay debts.
Think of your balances like a two-sided scale. Rather than having them lopsided one way or the other, it’s about finding the balance point. Where that balance point is depends on your industry, goals, and projections.
How account balances affect financial decisions
For many financial decisions a business makes, account balances should be consulted first. They provide one of the clearest pictures of the money a business has available to use in its operations.
Here are just a few of the ways account balances can be used in your financial decision making:
- Determining available cash flow: The account balances of your assets and liabilities will determine how much cash is available for funding day-to-day operations such as inventory purchases, rent bills, and salary and wages.
- Analyzing the capacity for additional credit: Taking out a loan or opening a new credit card could open up new opportunities, but checking your account balances ensures you won’t take on more than you can manage.
- Optimizing investment decisions: The balance of your assets represents the resources available to invest in growth of your operations, perhaps through new equipment, a new location, or research and development.
- Lobbying for investment: Investors will want to take a look at a business’s balance sheet before making their investment decision; understanding this helps you determine how ready you are to look for external investment.
It should be a regular practice to check account balances before making any major financial decisions. Doing so will help you identify how it could potentially impact the business and whether it’s the right thing to do at this point in time.
Types of account balances
Account balances can be broken into two types: assets and liabilities.
Asset account balances are the cash balances you hold. These balances increase as cash flows in and decrease with expenses and withdrawals.
Liability account balances are the balance of what you owe on debts. These balances increase as you use the available credit and decrease as you send money into the account.
With that established, let’s dig into some examples of account balances and how they show up in day-to-day operations.
Examples of account balances
When you look at your balance sheet, you’re likely to find some of these account balances.
The most common account balances in the assets section include:
- Cash On Hand: The physical money a business holds, possibly in a till or safe
- Checking Account: Bank accounts used for everyday spending with features tailored for making regular purchases, withdraws, and deposits
- Savings Account: Bank accounts used for saving that generate interest over time for passive income
- Digital Wallet: A platform like PayPal or Venmo which is used for sending and receiving money and can hold a balance
Meanwhile, in the liabilities section you’re likely to find account balances for:
- Credit Card: A card that the business charges purchases to on credit which must be paid back, typically on a monthly basis, otherwise interest and fees accrue
- Loan: Upfront capital that is paid back in monthly installments with interest
- Line of Credit: A type of loan where the business is entitled to a certain amount of credit from which they can take as much or as little as they need and only pay for what’s used
These are just a few of the different account types a business may hold. Your balance sheet will ultimately reflect the unique collection of accounts in your industry, specialization, or field of practice.
Understanding the implications of various account balances
The most important thing you should take away from account balances is how they can indicate whether a business is trending towards a short-term cash flow boom or bust.
High account balances in your liabilities section represent debt that needs to be paid. For a business to sustain a high level of debt, it needs to generate enough positive cash flow to make the regular payments.
In the assets section, high account balances show a surplus of cash that’s being held. This represents an opportunity to reinvest in the business, potentially investing in capital assets like real estate, equipment, or vehicles.
Ideally, these balances are being kept in proportion to each other. If the account balances of your liabilities is larger than that of your assets, there could be cash flow issues in the near future.
However, maintaining excessively high account balances for your assets can also be problematic. Cash on hand and checking accounts don’t generate interest and thus lose value due to inflation.
If you’re routinely covering your expenses and debt payments with the asset account balances growing over time, you should start looking for opportunities to invest that money and get a return.
While there’s no definite answer to whether an account balance is too high or too low, reassess your financial positioning every month and pay attention to how it’s trending. You may have more opportunities for growth than you think.
Real-life scenario showcasing account balances
A knitwear company makes sweaters that they sell wholesale to retailers. Their current operations involve buying raw goods on the 1st of the month and finalizing orders and invoicing retailers on the 15th of the month with net 30 terms.
They currently have an account balance of $10,000 in their bank account. But the upcoming bills they have include $5,000 in raw materials, $4,000 in labor costs, and $2,500 in operating costs. The sum of these costs ($11,500) is greater than their account balance.
This has become a recurring monthly issue where they don’t have the account balance on hand needed to cover their expenses, so they start planning.
With net 30 payment terms, they know that every on-time payment will be received before the 15th of the month following. If they can time their outgoing payments to be after the 15th, they know they’ll have cash come in before it needs to go out.
To do this, they first negotiate with their raw goods supplier such that they’re billed on the 1st of the month on net 15 payment terms.
Then, they open up a credit card to cover their operating expenses. With monthly billing, every purchase made on credit gives them a month to pay down the balance on their terms.
Now, they have a bank account balance of $10,000 and a credit card balance of $2,500. Once they pay their raw materials and labor costs bills, the bank account balance dips to $1,000.
While this isn’t an ideal situation, they were able to manage with their upcoming payments without going past due, find ways to optimize their cash flow, and are now better set up to maintain a healthy account balance every month.
How to calculate an account balance
To understand how to calculate account balances, you need to first understand debits and credits.
Every accounting journal entry is made up of debits and credits. Debits represent money flowing into an account while credits represent money flowing out of the account.
For accounts that are assets, debits increase the balance and credits decrease the balance. Comparatively, the account balance of liabilities increase with credits and decrease with debits.
With this information, there are two separate account balance calculations:
What impacts an account balance?
Essentially every financial transaction impacts an account balance. But in particular, these are the most common transaction types that will determine your ending account balance:
- Daily operating expenses: The day-to-day costs of keeping the business running and fulfilling sales
- Revenue generation: The money earned from sales or services
- Debt maintenance: Making payments towards credit cards, loans, lines of credit, accounts payable, or other liability; increasing debt from newly opened credit accounts or running transactions through credit accounts also affects account balances
- Interest and fees: Interest and fees paid on outstanding debt or interest generated on assets such as investments or a savings account
- Investment: Purchasing a high-cost item that is capitalized and delivers long-term value to the business
All transactions big or small impact account balances. It’s worthwhile to check on account balances on a regular basis depending on your transaction volume to ensure you’re staying within the limits you set for yourself.
How to maintain a healthy account balance
Account balances are directly tied to your cash flow. When you’re thinking about how to maintain a healthy account balance, you should be thinking about how to maintain a healthy cash flow.
The first thing you should do is create a budget and try to stick to it. Limit the money spent on expenses that aren’t generating value for the business by sitting down with teams individually and evaluating their related costs.
Some of the biggest cost sinks you should look into first are:
- Redundant and unused software expenses
- Marketing and advertising that isn’t generating results
- Rent and utilities for an unnecessarily large space
- Prices from vendors that haven’t been negotiated since starting the relationship
- Taxes that haven’t been optimized with deductions and credits
The second thing you should do is think about when money is entering and leaving the business. As an example, if your rent is due on the 15th of the month with debt payments on the 20th, but your payments are coming in after those dates, you could revisit your payment terms so cash comes in before it goes out.
It may be worth offering an early payment discount to your customers if you’re consistently worrying about getting paid before your bills are due.
Above all else, you need to make monitoring cash flow a routine part of your practices. By being proactive and identifying potential cash flow issues before they happen, you have the best chance of maintaining a healthy account balance.
Managing factors that impact your account balances
Every dollar earned and spent impacts your account balances. If you take control of your revenue and expenses, you take control of your balances.
This is where BILL comes in. With a full suite of financial tools including accounts receivables and accounts payable automation, expense management, corporate cards, and more, you can take back control of every dollar that flows through your business.
