From Proprietorship Books to a Net Worth Statement

Your capital account balance is the starting figure, not the final one

Start at the capital account, and expect to leave it behind. The capital account is the accounting record of the business's own funds: opening capital, plus profits, plus anything introduced, less drawings. In a proprietorship it is not another person's claim, so it never sits among the liabilities. It is a book figure, and a book figure describes only what has passed through the books.

That is why it is rarely the right answer on its own. A plot bought twenty years ago was never entered. A fixed deposit held outside the concern never appeared. Machinery written down to a token value is still cutting metal. None of those is stated correctly in the ledger.

Understatement is the usual direction, and three habits cause it at once:

• Fixed assetsare carried at cost less depreciation, not at what they would fetch.
• Stockis carried conservatively, often at the last purchase invoice.
• Anything held outside the trading nameis simply absent, because it never had a reason to be posted.

So the net worth of a sole proprietorship is not read off the capital account. It is built from it in four moves once the trial balance is drawn: close the period cleanly, remap the heads, restate the values, then add what was never there. Why the two positions are one is explained in its own article. This one takes that as read and shows the work.

Closing the books before anything else

Nothing later survives a careless cut-off. Fix the date the statement will speak from, then decide for every receipt and payment whether it falls before or after that date. An invoice raised on the last day belongs in receivables even if the money arrives a fortnight later. A cheque written that day and cleared the next week has already left the concern.

Where the concern keeps single-entry or incomplete records, the balances are reconstructed first, from bank statements, purchase and sale records and the stock position. Only then is there a trial balance to close.

Empty the suspense account next. Every entry parked there has to become either something held or something owed, and that difference is the whole point of the exercise. Clear these in the same sweep:

• unposted journals;
• unadjusted advances, paid and received;
• stale debit balances in supplier accounts;
• any head that has not moved in years, which is usually wrong rather than dormant.

Moving trial balance lines into assets and liabilities

A trial balance and a net worth statement are different documents.

The destination is assets set against liabilities, a much narrower document than a ledger.

Debtors, creditors and advances take the longest, because small ledgers often post opposite things into one group:

Line in the ledgerWhere it goes

Advance paid to a supplier

Assetsomething held

Advance taken from a customer

Liabilitysomething owed

Deposits with a landlord, utility or government department

Assetlisted separately from trade receivables

Input tax credit not yet used

Assetrecoverable

Tax collected and not yet paid over

Liabilityowed

Household expenses paid from the business account

Drawingsreduce capital, not a business cost

Personal receipts credited to the business account

Capitalintroduced

Where personal and business money have been mixed for years, separating drawings and introductions is usually the longest part of the work. It also matters for tax, because household spending is not a business expense.

Then strip out anything counted twice:

• A party who both buys and supplies can appear as debtor and creditor. Only the net is real, and only where a right of set-off exists with that same party.
• Cheques deposited but not yet credited can sit in two places at once.
• A transfer between two of the concern's own bank accounts inflates both sides if only one leg was posted.

Adding the columns as you go exposes an obvious duplication faster than reading the list again.

Adjusting book values to realisable values

Everything so far has been rearrangement. This step changes what the numbers mean. The ledger measures at historical cost less depreciation, because that is what a tax computation and a year-on-year comparison need. The statement measures at what an item would realise. For a long-running concern the movement is usually upward, sometimes a long way up.

• A shop bought decades ago and depreciated ever since sits in the books at a fraction of its market value.
• A machine written down to one rupee is still running and still saleable.
• Land carries no depreciation at all and stands at whatever was paid for it.

Each of those needs a fresh figure and a reason behind it:

The movement is not always upward, and a statement that only ever revises in one direction reads as advocacy. These come down or come out:

• goods unsold through two seasons;
• a balance owed by a customer who has stopped trading;
• a deposit with a party nobody can now trace;
• depreciation that was due but never posted.

Bring in liabilities the books have not yet recorded, such as accrued expenses and dues to statutory authorities.

Bringing in assets that never entered the books

Now add what the ledger had no reason to hold. None of these passed through the trading name, so none of them is in the trial balance:

• a flat in the owner's name, or a plot received from a parent;
• term deposits;
• a public provident fund balance;
• insurance policies with a surrender value;
• mutual fund units and shares in a demat account;
• a provident fund balance from an earlier salaried job.

Physical holdings need a firmer trail than the rest. Gold and jewellery are stated on a valuer's certificate, with purchase invoices where they exist and a note on how the holding arose where they do not. Vehicles are stated on the registration certificate with a dealer's valuation. The paper each holding needs varies by class, and gathering it before the statement is drawn saves drawing it twice.

Borrowings travel the same route in reverse. All of these are real, and none is in the business ledger:

• a housing loan
• an outstanding card balance
• a loan against a policy
• a private loan from a relative

Leaving one out is the error a lender finds fastest.

Handing the working papers to your CA

A clean working file is a short list:

1. The trial balance at the statement date.
2. The mapping sheet showing where each head went.
3. The change schedule, with a document reference against every line.
4. The valuation reports, bank confirmations and ownership documents those references point to.
5. One page on the basis used, dated and signed by whoever prepared it.

Expect the first questions in the same places every time:

• cash in hand that looks large against the concern's turnover;
• balances with relatives and connected concerns;
• an asset with no title document behind it;
• a borrowing with no confirmation from the lender.

The retained books usually answer these. Expect one more: whether the statement reconciles with the income tax return. Where the proprietor's return carries a balance sheet, that balance sheet and the business part of the statement describe the same concern, so they should agree after the adjustments made. Explain the differences in the file rather than leave a lender to find them.