Keep Projected Balance Sheets Simple

A projected Balance Sheet is a perfect example of the critical difference between planning and accounting. The Balance Sheet statement produced by accounting is full of important detail about each item, while the Balance Sheet projection in forecasting is necessarily summarized and aggregated.

This means that your balance sheet categories should be summary categories from your accounting. For example, assets categories are probably only Cash, Accounts Receivable, Inventory, Other Current (or Short-term) Assets, and Long-term Assets (or Plant and Equipment). Liabilities are probably only Accounts Payable, Current Notes (or Loans), Other Current Liabilities, and Long-term Liabilities. Capital is only Paid-in Capital, Retained Earnings, and Earnings.

There are two good reasons for this:

  1. You can only produce properly linked and correct fully balanced projections of Profit and Loss, Balance Sheet, and Cash Flow if there are exact links between the items on the Projected Balance Sheet and those in the Projected Cash Flow. That’s a fact of math and financial principles.
  2.  It’s useless to try to predict future assets and liabilities in detail; nobody can do it. So you might be able to estimate the total amounts of future purchases of assets, using some reasonable assumptions; but trying to estimate the month of purchase and value of each future asset is a waste of time.

In contrast to the Projected Balance Sheet, the Balance Sheet as a financial statement is a compiled report drawn from a database of details. Accounting knows each transaction: exactly when each asset was purchased, for how much, and its depreciation history and schedule. Accounting knows each loan (called notes) history. Every detail in the statement is based on actual transactions. It goes into tax reports and legal reporting. The projection, on the other hand, is a collection of educated guesses that help you plan your financial needs in advance.

Handling of depreciation is the best example. The accumulated depreciation in a Balance Sheet Statement is a summary of detailed depreciation for each asset the business owns. It comes from the depreciation in the Profit and Loss Statement, which is compiled from the detailed depreciation of each asset. Tax code defines allowable depreciation schedule for each asset according to type, so for example, buildings are normally depreciated over 30 years, while vehicles might be over three or five years. Depreciation in a Projected Profit and Loss, in contrast, is an estimated guess of an aggregated future amount. A good forecaster will look at depreciation over the recent past, plus projected purchases of new assets, to estimate future depreciation. That estimate ends up in the Balance Sheet as Accumulated Depreciation, which subtracts from the value of Long-term Assets.

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