Eli5 What does it mean to ‘balance the books’?


Eli5 What does it mean to ‘balance the books’?

In: 3

The “books”, in regards to a business is simply a ledger of income and expenses.

Balancing the books simply means to add up all the income and expenses, and to ensure that the income meets or exceeds the expenses.

Balancing the books is a basic part of maintaining finances…for a business or personal. The “books” are where transactions are recorded. Balancing the books is comparing what you think your account balance is with what another resource (like a bank or even a vendor) says your balance is.

People used to always have a physical checkbook for paying bills. You’d keep track of your payments and deposits in the checkbook. Once a month, you’d get a statement from your bank. The statement would list all of the transactions the bank processed for a specific period of time. You’d mark the transactions as ‘cleared’ if the bank has the same information you have.

For example….check number 347 was written to CVS for $22.53 on March 1. When you get your statement, you see thst the bank has paid that check to CVS, it has cleared your account.

On March 27, you wrote a check to your niece for $75 for her bday. She hasn’t cashed the check yet. Therefore, the balance the bank is showing is $75 more than the balance you’re showing for the account.

Knowing which transactions are outstanding (the check to your niece) help you have a better understanding of your balance…and keeps you from becoming overdrawn.

Most all of this is done electronically these days.

This comes back to a system of accounting called “[double entry bookkeeping](https://en.wikipedia.org/wiki/Double-entry_bookkeeping)”. Basically, whenever you have a transaction, it should affect at least 2 separate accounts e.g. a loan gets you $10k in cash, but adds $10k to your liabilities (debt) so overall, the loan hasn’t changed your financial position because you’ll have to pay it back later. This allows for a cross check to make sure you haven’t missed anything in your accounts.

If you do a job on account (get paid later) you get income so you add this to your “sales” account as a debit (increase in assets) but I also need to show where this money is going so I credit my wages and inventory accounts to show that I no-longer have the materials I used and I have to pay my people. I also need to credit my profit account for the left over money. Now my debit (the sales revenue) balances the credit (what happened to that money). The money owed to me counts for accounting purposes as an asset equivalent to having the cash though we also need to track cash since I can’t transfer that debt to my suppliers to pay my bills

Later, I get paid for the job so now my “sales” account is credited (reduced) because I am no-longer owed money but my “cash” account is debited (increased) as I now have the money in my hand / bank account. Again, my books still balance – since this was just collecting money owed, my overall position hasn’t changed.

Balancing the books means going over all of your accounts and confirming that they all agree with each other. (Also see [debits and credits)](https://en.wikipedia.org/wiki/Debits_and_credits)

Accounting is “double entry” meaning that every transaction has a “debit” side and a “credit” side that equal each other. The basic accounting equation is: Assets = Liabilities + Equity

The reason the equation always balances out is because every entry to the books must balance.

Here’s an example:

Your company has $100 and buys $100 of inventory: Debit Inventory $100 / Credit Cash $100

…then sells all of it for $150: Credit Inventory $100 / Debit Cost of Goods Sold $100 / Credit Sales $150 / Debit Cash $150

Each entry balanced (debits=credits), so your books are balanced. Back to the equation:

Assets (cash): $150

Liabilities: $0

Equity: $100 (the original $100 you had in your account)

Income: $150

Expenses: $100

At the end of the period, you move net income to equity, so the $50 in net income is added to the $100 beginning equity, and now

Assets ($150) = Liabilities ($0) + Equity ($150)

Perfectly balanced.


The other way to look at it is what is called a “Trial Balance” – the TB lists every account on the ledger, and the balance in each account is either a Debit (expressed as a positve number) or Credit (expressed as a negative number), and if you add them all up, you get zero.

From the example:

Cash 150

Equity (100)

Income (150)

Expenses 100

Balance 0

Most of these comments are far from ELI5 answers.

At it’s heart this term just means keeping accurate and complete financial records. Typically this term would be used by a “bookkeeper”, or accountant, to describe the process of producing financial statements for a business at the end of any reporting period, e.g. a month or a year, and checking to ensure they’re correct.

In essence, they want to make sure all of the transactions for a period are recorded. When people used paper checks to make payments they would call this “balancing” a checkbook, making sure that a ledger, or list, of all the checks they’ve written corresponds to the balance in their account, or “book”.

The bank would not keep a detailed record of your transactions, e.g. who you’re paying with each check. A bank statement would only include a list of checks by check number, or numerical identifier. People would manually keep a record of all the checks they’ve written (who they paid and how much) and check it against their bank statement. That process, the verification, was referred to as “balancing”.

Accountants keep many lists, lists of sales made, lists of expenses, lists of payments made, lists of payments received, etc. They “balance” (verify) many “books” (accounts).