What is an opening balance and why is it important?
Anyone entering the world of business accounting for the first time will find a whole range of unfamiliar terminology being bandied about. From “fiscal years” to “working capital”, from “accrual accounting” to “operating cash flow”, it’s easy to get lost in this terminological jungle. Mooncard is on a mission to help you understand some of these key terms and to explain the practical implications for your business.
The concept of an “opening balance” is key to really getting to grips with the financial health of your business and setting the pace for the year ahead.
What is a company’s opening balance?
Understanding exactly what your opening balance is, how to calculate it, and how to enter it into your accounts is essential for you to be confident about the future of your business.
In the simplest of terms, a company’s opening balance refers to the funds in its account at the start of a new financial period. The opening balance is the first entry in the company’s accounts when it first begins trading and at the start of each new accounting period.
For example, Steven runs a painting and decorating company. He has a balance of £3,500 in his business account on 31 December, the end of his accounting year. This is his closing balance. On the next day, 1 January, a new accounting period begins, and Steven carries forward his £3,500, entering it as his opening balance for the new accounting year.
The closing balance recorded in the year-end account is brought forward and is identical to the opening balance at the beginning of the next accounting period.
Depending on the net cash flow of the company in question, the opening balance may be either on the credit site or on the debit side of the company’s ledger – in other words, it can be a positive amount or a negative amount.
While the closing balance of any specific financial period is key to analysing the company’s activities and performance over that period of time, the opening balance is the cornerstone of any successful company’s approach to forecasting the future. It is a key indicator of the company’s financial health and an indicator of where and how the company can grow.
Calculating your opening balance
When a company first begins operations, its very first opening balance will be zero, unless funds have been spent before the company was established.
In many cases, the business owner will invest funds into the company in order to set it up, either from their own savings, in the form of investments from “angel” investors or a loan from the bank. All these have to appear as part of the business’s opening balance.
A very simple example can illustrate how the opening balance of a company is calculated.
Let’s take the example of Molly. Molly set up a catering business, selling sandwiches to the staff of local businesses and students. Her company began trading on 12 March 2021, with an opening balance of £15,000 which she invested from her own funds. Over the course of her first year in business, she received £27,000 from her customers, but had to pay out £14,000 to cover her expenses.
On 11 March 2022, Molly closed her accounts and calculated her closing balance using the following formula:
equity + credits – debits = closing balance. In this case, her calculation looks like this: £15,000 + £27,000 - £14,000 = £28,000.
Molly’s closing balance is calculated as the sum of the difference between all the credits and debits of her business over the twelve-month accounting period. The closing balance of £28,000 is then carried over to her next year and becomes her opening balance for the year which will begin on 12 March 2022.
Balance brought down and balance carried over
Not content with simply introducing new terms and concepts into our vocabulary, accountants also like to use abbreviations, just to keep us on our toes! CAP, OCF, CFO, GL … where to begin?
Two of the most common abbreviations that crop up when tackling the accounting process are “b/d” and “c/d. Let’s take a minute or two to get to grips with these concepts.
A balance is described as “brought down” (b/d) when it is carried forward from a previous accounting period. In other words, it is synonymous with the term “opening balance”, as we explained it above.
A balance is described as being “carried down” (c/d) when it is carried down from one accounting period and onto the next. It is synonymous with the term “closing balance” which is explained in more detail above. In other words, the balance c/d of one year becomes the balance b/d of the next.
Creating an opening balance sheet
Balance sheets are documents used to track a company’s assets and liabilities, or, in simpler terms, what it owns and what it owes. When a company first begins trading, every asset of the company must be valued and recorded. Vehicles, premises, hardware, office furniture, it all has to be included in the opening balance sheet as “assets” of the company. These may also be coupled with “liabilities”, or debts, if equipment has been purchased through bank loans or investments from other parties.
Once the business is up and running, unforeseen events may also lead to bad debts having to be estimated and written off. These also have to be taken into account in the opening balance.
With your assets and liabilities recorded, as well as any owner equity which has been invested in the company, your opening balance sheet can be drawn up.
For example, if Helena buys a new computer for her office for £600, her assets will increase by £600 but her bank account will decrease by the same amount. Obviously, in a more complex and realistic scenario, depreciation of the asset will have to be taken into account and the expense may be amortised over a set period of time.
Remember, the most basic accounting principle is that both sides of the balance sheet must … you’ve guessed it … balance if the company is going to break even!
How can accounting software help?
Meticulously keeping track of all expenditure and income is the key to ensuring your business’s assets, liabilities and equity are “balanced” at the end of the accounting period. Tracking financial transactions accurately also makes it much easier to calculate the company’s closing and opening balances at the end and start of each financial reporting period.
You may choose to have shorter financial periods in order to keep an even closer eye on your business. For this reason, you may want to introduce opening and closing balances on a monthly basis, quarterly or six-monthly basis.
By introducing accounting software into your business model, these decisions can be made so much easier. You can keep track of your accounts and get a real-time snapshot of your company’s financial health at any given time with just a few clicks. Cash flows become more visible and forecasts can be made more easily on the basis of accurate facts and figures.
However, without accurate data being entered into the system, even the most highly-performing accounting software will struggle to give you meaningful output. Introducing streamlined cash flow and bookkeeping procedures can make sure your accounts are kept on track.
Mooncard offers simple, tailor-made solutions which can allow your closing balance to be carried over automatically into the next accounting period, seamlessly setting the groundwork for the year ahead. Whether you use accrual or cash flow accounting methods, financial statements can be generated on demand, whether it be for audit purposes or just for internal analysis.
All this frees you up to spend your time on what really matters, your business! Get in touch today for a no-obligation, free demo to find out what Mooncard can do for you.