What it means
Every account in a set of books carries a running balance, and that balance changes with each transaction posted to it. A bank account balance rises with receipts and falls with payments; a customer account balance rises with invoices and falls with cash received and credit notes issued.
The balance is simply the accumulated net effect of everything that has happened so far. The direction of a balance tells you which side of the books an account belongs to.
Asset accounts such as cash, inventory and amounts owed by customers normally carry debit balances, while liability, equity and income accounts normally carry credit balances. When an account carries a balance in the opposite direction to normal, that is a signal to investigate rather than something to ignore.
In everyday business conversation, account balance most often means the figure your bank or card provider shows. That figure can differ from the balance in your own books because of timing, since a cheque you have written or a card payment you have authorised may not have cleared yet.
The gap between the two is what reconciliation exists to explain. Balances also come in two useful flavours: the current balance and the available balance.
The current balance is everything recorded, whereas the available balance strips out funds that are committed but not yet gone, such as pending card holds. Confusing them is one of the more common ways a business accidentally overdraws.
For management purposes, a single balance is rarely enough on its own. A debtor balance of $135,000 means something quite different if it is one customer paying in seven days than if it is thirty customers averaging ninety days.
Balances are most useful when read alongside their ageing and their trend over several months.
In practice
Real-world examples.
Example
A cafe owner checks the business bank balance on a Friday afternoon and sees $18,400. She knows that a $9,000 rent payment and a $4,200 supplier direct debit are due on Monday, so the meaningful figure is closer to $5,200. She delays a planned equipment purchase by a fortnight rather than risk a bounced payment.
Example
A software company's finance manager reviews the deferred revenue balance and finds it has grown to $860,000. Because that balance represents services already paid for but not yet delivered, the growth is good news for cash and a future obligation at the same time. He flags both readings in the board pack.
Example
A wholesaler notices that one customer's account balance has sat at exactly $22,500 for four months while new orders keep arriving. The frozen balance turns out to be an unapplied credit note, not a payment problem, and clearing it removes a false red flag from the credit control report.
Formula
Calculation
Closing balance = Opening balance + Increases - Decreases
Take the trade debtors account, which records money customers owe. The opening balance at the start of the quarter is $128,000. During the quarter the company raises new invoices totalling $310,000, receives cash from customers of $295,000, and issues credit notes for returned goods of $8,000. Closing balance = $128,000 + $310,000 - $295,000 - $8,000 = $135,000. The arithmetic runs $128,000 plus $310,000 gives $438,000, less $295,000 gives $143,000, less $8,000 gives the closing balance of $135,000 owed by customers at quarter end.Case study
Seen in the real world.
Harborline Print is a fictional commercial printer created to illustrate how account balances can mislead when read in isolation. Its owner watched the bank balance every morning and treated anything above $60,000 as comfortable. On that basis the company signed a lease for a second press with monthly payments of $7,400.
What the daily bank balance concealed was the shape of the trade creditors account, whose balance had drifted from $95,000 to $180,000 over nine months as the business quietly stretched supplier payment terms. The healthy-looking bank balance was, in effect, borrowed from suppliers who had not yet been paid.
Once the owner started reviewing the bank balance, the debtor balance and the creditor balance side by side each week, the real position became visible. This example is illustrative, but the habit it recommends is real: no single balance is a verdict on a business, and balances only tell the truth in company.
Watch out
Common mistakes.
- Reading the bank balance as though it were profit. Cash sitting in an account may belong to suppliers, staff or the tax authority, and a healthy balance can coexist with a loss.
- Ignoring the date on a balance. A balance quoted from three weeks ago can be badly out of line with the position today, particularly in a business with heavy weekly payment runs.
- Confusing the available balance with the current balance and then authorising a payment that pushes the account into an unplanned overdraft.
Questions
People also ask.
Why does my book balance differ from the bank's balance?
Timing differences such as uncleared cheques, deposits in transit and bank fees not yet recorded explain most of the gap, and reconciliation identifies each one.
Does a credit balance always mean money is owed to someone?
Not always, since a credit balance on a customer account usually means the customer has overpaid or holds an unused credit note.
How often should balances be reviewed?
Cash and debtor balances deserve weekly attention in most businesses, while less volatile accounts are usually fine at month-end.
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