When you're focused on the day-to-day running of a business, it can be difficult to stay on top of cash flow and know where you stand financially on any given day.
Premium bakery Cutter & Squidge sells cakes and more through its London-based store and café, as well as a nationwide eCommerce business. Baked fresh every day, there’s a constant flow of ingredients coming in one end and treats flowing out the other. Using a trial balance in accounting on an ongoing basis helps Co-Founder and CEO, Annabel Lui, retain control of the company’s cash flow. “If you’re not financially minded, it’s easy to run out of cash quite quickly," she says. "Trial balance can help you keep an eye on that."
What is a trial balance?
“A trial balance is one of the most fundamental things I learned when I first started in accountancy,” says Parry Jackson, a partner in accountancy firm Price Bailey’s business development department. “Essentially, it’s a single statement that summarises all the numbers in a company’s books and records. It’s the building block of your financial statement.”
The trial balance records each financial transaction you make – from paying rent to making a sale – in two different columns: the debit column on the left, and the credit column on the right. The total debits should always equal the total credits. If they balance, there are no errors in the ledger. If not, you must go back into your statements or receipts to investigate the discrepancy.
Trial balance vs. balance sheet
Trial balance lists the end balance of every account and is only ever used internally or by a company’s auditors.
The balance sheet can also be used internally, but it is also an official document as part of the company’s financial statements. As a result, it must comply with the UK-adopted international accounting standards (IAS) whereas a trial balance doesn’t have any particular format (other than debit and credit columns).
Finally, while a balance sheet groups several accounts into one figure, the trial balance shows every account individually, so it can end up being very detailed.
What is a trial balance used for?
Typically, the trial balance is the first step in preparing your annual financial statement. However, businesses can also use it to keep an eye on their cash ensuring money is always in the right place, at the right time.
“If you do this on a regular basis, your accounts become much easier,” advises Lui. “This way I can understand who owes me money – and who I owe money, making sure that it’s paid and cross-checked and that it aligns with the bank account."
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What does a trial balance include?
Simply, a trial balance includes every transaction the company makes. “It comes down to that famous phrase ‘double-entry bookkeeping’ - every debit has a credit, and vice versa,” Jackson summarises. In other words, you record each transaction twice.
Typically, the transactions will fall under one of five major accounting categories:
- Assets – what you own
- Expenses – usual costs i.e. rent and salaries
- Liabilities – what you owe
- Equity – assets minus liabilities
- Revenue – what your business earns
For example, if you were to buy a computer – an asset – for £2,500 in cash, the debit column would show £2,500 (Debit: Equipment £2,500).
At the same time, the liabilities account in the credit column would also show £2,500 (Credit: Cash £2,500). This is because you now own £2,500 worth of equipment but owe/paid £2,500 from your cash.
How to prepare a trial balance
“It’s very easy to pull a trial balance together,” Lui says. In fact, if your business is using common accountancy software, it automatically records your transactions on a trial balance as you go along.
Here are the three main stages of preparing a trial balance:
Step one
Coding – or putting transactions in the right category – is the first step towards making sure your lists balance. You either categorise your transactions manually in your ledger or spreadsheet or choose one of the categories provided by your accounting software each time you log a transaction. Typical categories include:
Debits
- Inventory
- Expenses
- Equipment
- Interest payments
- Taxes
- Returns
Credits
- Sales (goods or assets)
- Accounts payable
- Supplier refunds
- Owner equity
Lui warns this first step is possibly the easiest place to introduce an error into your trial balance. “Most errors come from how you code a transaction, especially if you have lots of them," she says.
"We are a direct-to-consumer business so we have a lot of moving goods, and lots of ingredients coming in. It’s really tempting – I’ve been a culprit before – to just clear your transactions to get them into your software. But, if they’re posted in the wrong place, it might show as an unexpected cost and you then wonder why it’s not balancing."
Step two
Enter all your transactions in the respective credit and debit columns and generate the totals for both.
“You have to be quite disciplined, especially if you’re an owner and founder and you’re running the business yourself,” Lui admits. “You need to take time to update your trial balances regularly. Modern accounting software will help you do that, but you still need to make sure you’re cross-checking and that you have those debits and credits balancing.”
Step three
If the totals do not balance, you will have to go back to the source of the disputed transactions to find out where the mistake may have been made.
Jackson suggests this isn’t as demanding as it sounds. “It’s very difficult to make a mistake if you’re using accounting software but common errors happen when a transaction is omitted," he says.
"Say you forget to enter a bank transaction into your ledger, software won’t notice that. Or, if you’ve accidentally recorded your rent as stationery. By going back and looking at your trial balance sheets, you can say ‘I’ve definitely not spent £1,000 on stationery in the last month so that one must have been the rent’.”
Example of a trial balance
| Account | Debit | Credit |
| Inventory | £5,000 | |
| Accounts Payable | £4,750 | |
| Cash | £6,000 | |
| Sales Revenue | £10,000 | |
| Accounts Receivable | £1,000 | |
| Expenses | £3,250 | |
| Equipment | £2,750 | |
| Wages Payable | £3,250 | |
| Totals | £18,000 | £18,000 |
Whether you want to keep track of your remaining cash, or just be certain that your end-of-year finances are error-free, compiling a trial balance is an essential part of your bookkeeping process. Fortunately, for most, it’s also a piece of cake.
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