So many people overlook the Balance Sheet. The Income Statement gets all the love!
... and the scrutiny.
Operators want to know their “bottom line” and focus tons of energy towards hitting specific sales targets, controlling their expenses, and meeting a target profit margin. And while yes, those are all great goals, the Income Statement doesn’t mean squat if the Balance Sheet is not accurate!
Let me explain…
Accounting systems are all built around a chart of accounts, and ALL financial statements are created from those accounts. Some of the accounts are on the Income Statement (Income and Expenses) and some are on the Balance Sheet (Assets, Liabilities, and Equity). If you ONLY look at the Income Statement, you are ignoring a HUGE chunk of your accounts, and ANYTHING can be hiding there!
Well, not anything. A snake won’t be in there, or at least not literally.
Now if that seems like common knowledge to you, just stick with me! Throwing shade to your Balance Sheet is something TONS of hoteliers do, even if you do get the gist of it.
OK, since we’re all in agreement that the Balance sheet is super important, let’s discuss
four RED FLAGS to watch out for when reviewing your Balance Sheet:
1) First things first, the Balance Sheet should be…IN BALANCE.
That means that your Total Assets should be the same number as your Liabilities plus your Owner’s Equity (there should be a line for L+OE, so you don’t need to add them together).
Most people know that one and most accounting software’s will throw a warning at you if you’re out of balance, but still do a quick check!
2) The other key element for the Balance Sheet to even be valid is that the Current Earnings line on the Balance Sheet MUST be the same number as the Year to Date Net Income on your Income Statement.
If it isn’t, something is missing from one of those reports, or the calculations on one of them are off. Kick it back to your accountant immediately. Trying to analyze a Balance Sheet with either of these first 2 problems is a waste of your time.
3) This one is only slightly less obvious. It should be a red flag when an account is negative on the Balance Sheet (AKA, it’s going in the wrong direction).
At this point, you may be thinking, aren’t some accounts supposed to carry negative balances?
Well…..yes. Accounting systems are based on debit (positive) accounts and credit (negative) accounts, but that basically means NOTHING to non-accountants, which is why all accounts on financial statements are usually shown as positive numbers.
This red flag could be alerting you to a ton of different problems. Every account will have to be analyzed separately.
Let’s go over a few examples though just to make sure this one sinks in:
A prepaid account for instance. A prepaid account is used if a purchase you make, like an
insurance premium, should be expensed out over several months. When you pay the invoice, it is originally coded to prepaid, and then a journal entry is made every month to expense out some portion of that invoice. If a prepaid account is negative on the Balance Sheet, it means more money has been expensed out on your Income Statement than was originally put on the Balance Sheet.
Your Income Statement might look completely normal, because the regular journal entry to expense insurance has been made, but the negative prepaid balance on your Balance Sheet would alert you that you no longer have anything in prepaid insurance.
That will prompt you to ask: do we have a new insurance policy? Are we behind on paying insurance? Did we get a new policy and code it to the wrong place?
Ok, one more example. Sales Tax collections. When customers pay their bill, they pay you your rate plus a % for sales tax. Sales Tax Payable is a liability account where you record all of the sales tax you are collecting that you will later pay to the City or County or State.
The idea is that all your collections go to this account and then a payment is made to zero it out. If that account is negative on the Balance Sheet, that would alert you that your payment was more than what was collected.
That would prompt you to ask: are our collections calculating correctly when a customer’s bill is created? Is tax-exempt revenue being tracked accurately?
The main takeaway of this red flag is that any negative number on your Balance Sheet should prompt you to ask questions!
Even if you don’t know exactly what question to ask, a great place to start is “can you explain this account balance to me?”
4) This is a big RED FLAG that is overlooked the most often. An account is growing that shouldn’t be.
Even if you aren’t super comfortable with the Balance Sheet, a negative number on the Balance Sheet might jump out at you, but more often an account just sits quietly in the background, growing unnoticed…and unexplained.
Maybe an Accounts Receivable account is growing and growing every month, and you start to think, if our revenue is so high where the heck is all of our money?
Perhaps your AR balance has been getting out of control and its time to start collecting that money!
Or…gulp…start writing off uncollectible balances.
Maybe Tips/Gratuities Payable (money that is collected to pay tips to wait-staff on payroll) is getting bigger and bigger each month. This is a common one we see and might alert you that the tips that are being paid out on payroll are being expensed with wages OR it might alert you that you are only paying out a portion of the tips on payroll and keeping a portion as revenue. In which case, you’ll need to move that revenue to the
So there you have it! Those are the most common red flags to watch out for on the Balance Sheet!
PLEASE do not feel like you have to know exactly what every single red flag on your Balance Sheet means before you start asking questions. So many hoteliers have Balance Sheet issues that are huge and far-reaching because 1) they did not notice the red flags or 2) they weren’t sure exactly what they meant and they weren’t sure what to ask, so they just didn’t.
Friends, please hear me say this with love, digging your head in the sand or crossing your fingers and hoping for the best is NOT A GOOD STRATEGY!
Your accounting team should have backup work papers for ALL Balance Sheet accounts.
They should be able to tell you where the numbers came from, and have a schedule for if/when they will be expensed/amortized/etc.
And I will say again, if something looks off to you, a great (and EASY) place to start is just to ask “can you explain this account balance to me?”
That will get the conversation started, help you understand your balance sheet, and IF there is a problem, be the first step in solving it! Don’t be in the dark.
You’ve got this!