A balance sheet is only a snapshot of a business’ financial position on one particular day. It is so-called because there is a debit entry and a credit entry for everything (but one entry may be to the profit and loss account), so the total value of the assets is always the same value as the total of the liabilities.
The balance sheet will show:
- How solvent the business is,
- How liquid its assets are (i.e. how much is in the form of cash or can be easily converted into cash such as stocks and shares)
- How the business is financed
- How much capital is being used. The individual figures can change dramatically in a short space of time but the total net assets (assets less liabilities) would only do so if the business was making large profits or losses. Any profits not paid out as dividends are shown in the retained profit column.
What the balance sheet doesn’t do is show day-to-day transactions or the current profitability of the business. However, many of its figures relate to (or are affected by) the state of play with Profit and Loss transactions on a given date.
The balance sheet is comprised of the following:
Current Liabilities – what the business owes and must repay in the short term (usually within 1 year) such as:
- Money owed to suppliers
- Short-term loans, overdrafts or other finance which won’t appear on the Profit and Loss, the latter will include interest payments on that loan in its expenditure column – and these figures will affect the net profitability figure or ‘bottom line;
- Taxes due within the year – VAT, PAYE and National Insurance
Long Term Liabilities – creditors due after one year such as:
Amounts due to be repaid in loans or financing after one year, eg bank or directors’ loans, and finance agreements
Capital and reserves – share capital and retained profits, after dividends (if the business is a limited company), or proprietors capital invested in business (if the company is an unincorporated business)
By law the balance sheet include the elements shown above in bold. However, what each includes will vary from business to business. It will be the firm’s external accountant who will usually decide how to present the information.
Note: The balance sheet should also include any statements and signatures by the landlord or agent required by the lease. If there is no such requirement, it is good practice for the landlord or agent, (as applicable), to sign the balance sheet to confirm approval of the accounts. There is no statutory requirement as to the form or content of the balance sheet.
Current Assets: The assets of a company are recorded as debits (a good thing) which are expected to be converted into cash, inventory and accounts receivable within 12 months of the balance sheet date. It can also be termed a liquid asset. Their value can fluctuate from day to day and can include:
- Inventory (which is often the largest item in the current assets category), which must be accurately counted and valued at the end of each accounting period to determine a company’s profit or loss;
- Work in progress;
- Petty cash;
- Debtors (people or companies) who owe the business money for goods or services supplied. These are broken down into trade debtors (who are suppliers that give a grace period in which to pay after services have been provided) and other debtors. The amount that goes on the balance sheet for trade debtors is the sum of all unpaid customer invoices as at that point in time. A provision is usually made in the accounts of a firm to to offset uncontrollable accounts receivable (bad debts) as losses.
- Cash in hand or at the bank: The amount shown here will be determined partly by the income and expenses recorded in the Profit and Loss Account Account. So if spending in the period before publication of the accounts is overtaken by the sales income, it should mean that current assets will be higher than if expenses had outstripped income over the same period;
- Short-term investments;
- Pre-payments – eg advance rents.
*Points 3 and 4 are Added Together*
These are long-term possessions which include tangible assets such cash, machinery, buildings, fixtures and fittings and land. These assets are broken down into the following:
- Depreciation (a decrease in the value over time);
- Net Book Value which is the value at which a company carries an asset on its balance sheet. It is equal to the cost of the asset minus accumulated depreciation.
Accounts Receivable: This is the most liquid asset behind cash and is also usually considered tangible assets for accounting purposes. Accounts receivable are shown as current short term assets in the balance sheet and are in fact unsecured promises by customers to pay in the future rather than at the time of purchase.
Intangible Assets: Intellectual property rights (i.e. trade marks, patents and website domain names) and long term investments.
Net Current Assets
These are Creditors with amounts falling due within one year and subtracted from Cash at Bank and In Hand:
- Taxation and Social Security
- Other Creditors
Total Assets Less Current Liabilities
Capital & Reserves: Generally capital is the money invested in the business. Reserves are the accumulated and retained difference between profits and losses year on year since the company’s formation.
- Profit and Loss Account: This is the statement of movements on the profit and loss account
Shareholders Funds (if applicable)