Launching a new business, whether a SaaS startup, a retail business with physical stores, or any other entrepreneurial venture, is fraught with uncertainties. Unlike large corporations with substantial cash reserves, startups and small businesses often struggle to build their financial cushion, especially in the early stages of growth.
As a founder, it's vital to keep a close eye on your business's cash flow — monitoring the money coming in and going out and understanding how much cash runway you have. To gain a comprehensive and objective view of your company's financials, you must familiarize yourself with the essential financial statements, such as the trial balance and balance sheet, and comprehend their interconnections. Moreover, investors and creditors often rely on these financial reports to assess your business's financial health before providing funding.
In this article, we compare a trial balance vs. a balance sheet and help you understand their purpose, composition, and structure, and how to utilize them effectively.
What Is Trial Balance?
A trial balance is a financial statement that lists the ending balances of all accounts in your company's general ledger for a specific accounting period. In visual terms, you can think of it as a balancing scale. On one side, you have debits; on the other, you have credits. By ensuring the total debits equal the total credits, the trial balance helps to identify and correct any potential bookkeeping errors in balancing accounts. It's usually used as an internal document that provides a consolidated view of your company's financial transactions for a specific period.
What Is A Balance Sheet?
A balance sheet, also known as a statement of financial position, is a critical financial statement that provides an overview of your company's financial health for a specific reporting period. You can think of it as a financial photograph that captures the following information:
- Assets: Everything of value that your company owns — equipment, inventory, cash, buildings, or intellectual property like patents and trademarks
- Liabilities: Anything your company owes to others — accounts payable, wages payable, loans, etc. You can think of liabilities as your company's outstanding debts.
- Shareholder Equity: This represents the amount of money shareholders have invested in your company and any retained earnings, like dividends, which you have not yet disbursed to shareholders.
The Key Differences Between Trial Balance Vs. Balance Sheet
Let's take a closer look at the differences between the two.
Purpose And Function
While the trial balance and balance sheet are critical financial statements, they play distinct roles in financial reporting. One of the important purposes of trial balance is to act as an internal control mechanism, ensuring the accuracy of the double-entry bookkeeping system. Verifying the total debits match the total credits helps to identify different types of errors like typos, incorrect or missing journal entries, and other inconsistencies. This ensures the accuracy of subsequent financial statements like the income statement and balance sheet, which are prepared using the information in the trial balance.
Unlike the trial balance, which is an internal report, the balance sheet serves as an external communication tool. It presents your company's financial standing in a clear and concise format, categorized into assets, liabilities, and shareholders' equity. This facilitates internal decision-makers and external stakeholders in understanding how the company is financed, what it owns, and how much it owes. It gives an overall picture of your company's financial health, liquidity, and solvency.
Composition And Structure
Each line in the trial balance lists the specific name of a general ledger account, along with the closing entries and ending balances. This balance is categorized as credit or debit, depending on the account type. For example, since accounts payable (vendor payment, salaries) are a liability, they're listed as credits. On the other hand, accounts receivable (customer invoices) are listed as a debit since they're an asset.
The trial balance sheet usually has three columns:
- Account name: This column lists the names of all general ledger accounts.
- Debit: This column displays the total debit balances of all accounts included in the trial balance.
- Credit: This column displays the total credit balances of all accounts included in the trial balance.
For a balanced trial balance, the debit column's total must equal the credit column's total. This signifies that, based on the double-entry accounting system, every debit has a corresponding credit, and vice versa. Any discrepancies in these accounting balances indicate potential errors in the bookkeeping records.
In contrast, the balance sheet has two sections:
- Assets: These are usually recorded on the left side and categorized by their liquidity (current vs. long-term).
- Liabilities & Equity: These are recorded on the right side and include liabilities (current vs. long-term) and shareholder equity.
The balance sheet uses the accounting equation assets = liabilities + equity, ensuring the two columns always have the same total value.
Timing And Frequency
Preparing trial balances is more frequent, usually at the end of every month, quarter, and year, depending on your company's accounting cycles, procedures, and needs. This allows your accounting team to identify and correct bookkeeping errors before finalizing the financial reports. In contrast, balance sheets are generated less often, usually once every quarter or year.
Impact On Financial Analysis
The trial balance software is the starting point for creating other financial statements like the balance sheet and income statement. Highlighting any errors in the balance accounting system prevents inaccurate data from being used in further financial analysis. In contrast, the balance sheet forms the basis for calculating various financial ratios like liquidity, solvency, and profitability.
Leverage Both For Comprehensive Financial Understanding
The trial balance and balance sheet work together to provide a robust foundation for financial analysis and reporting. The trial balance ensures the accuracy of underlying data, while the balance sheet translates that data into a meaningful picture of the company's financial standing.
Knowing how to read and interpret the balance sheet and trial balance provides you with critical data to make informed business decisions. Ready to get started with these key financial documents? Learn how you leverage the power of AI to create and generate these reports without hiring expensive financial professionals.
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