The Balance Sheet
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A balance sheet shows a business's assets, liabilities, and capital. Assets include fixed assets like buildings and equipment, and current assets like inventory, cash, and amounts owed by debtors. Liabilities include current liabilities owed to creditors and loans, as well as capital invested by shareholders. The balance sheet balances by showing that assets are equal to the sum of liabilities and shareholders' capital. It provides information about a business's financial health and ability to pay debts.
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The Balance Sheet
- 1. Understanding a Balance Sheet
Editor's Notes
- This presentation provides an overview of the key points in this chapter. Note for tutors: If you wish to print out these slides, with notes, it is recommended that, for greater clarity you select the ‘pure black and white’ option on the PowerPoint print dialogue box.
- This concept is worth discussing at length. It paints a very simple picture of the basic components of a balance sheet. Using examples will help to illustrate the point. ‘Borrowed’ money could include loans from a bank, shareholders, investments and even the owner’s own capital. This category also includes the money which the business owes to suppliers. Assets are items ‘owned’ e.g. buildings, material and stock. The key point is that, in a balance sheets, businesses have to show what has happened to all of the money borrowed or invested.
- Assets are items of value which the business owns. In effect, they show what has happened to the money invested in, or borrowed by, the business. On the balance sheet they are divided into fixed assets and current assets. Fixed assets could not be sold quickly and, in any event, are normally needed for the business to carry on working. However, in certain circumstances they may be sold, eg a production company could sell factory premises it no longer needs or a retail firm could relocate and sell a former shop premises.
- Current assets are items the businesses uses on a day-to-day basis. They consist mainly of materials used in production or finished goods (or stock) for sale. Debtors, people or businesses which owe money are included in this category. This is because, once the money is paid, it will increase the amount held in the current bank account.
- The idea of current liabilities is fairly straightforward. Just as businesses are owed money by debtors, they also owe money to creditors which must be paid. Very short term loans are also included in this section, such as bank loan which must be repaid within a year.
- The capital and reserves section lists all the money which belongs to the shareholders. It consists of the amount they have invested, plus profit which has been retained (as opposed to being distributed as dividends). It also includes the profit retained from the financial year which as just ended.
- This slide shows the first part of a balance sheet, with specific figures under each heading. The items in italics are calculations made from other figures. It should be fairly clear to students that these are two basic additions. However, the final total – although mentioned – never actually appears in this form on the balance sheet.
- In this example, the company owes £10,000 in bills to suppliers. This is always shown as a minus figure, because it represents money to be paid. The first calculation – again shown in italics – shows this amount deducted from the current assets. The reason for this is to provide a quick check on the financial ‘health’ of the business. If the figure is positive, this means the business could repay all its current debts (£10,000) more or less on demand. However, if in the case above, the business had owed £50,000, then it would have been £10,000 short if creditors demanded their money and the net current assets/liabilities figure would have been shown as a negative. The final calculation shows the result when the current liabilities have been deducted from the total assets. This is a very important calculation which must agree with the final total – see next slide.
- This shows the different aspects of the shareholders’ funds – each with an amount. The total on this section must equal the final total as shown on the previous slide, ie total assets minus current liabilities.
- This summarises the balance sheet which shows how all the items fit together. It usefully leads to the balance sheet on page 374 of the Student Handbook. Tutors may wish to point out that in the example above, the total assets (A + B) = £120,000. Therefore the total liabilities must also equal £120,000. This can be proved by adding the current liabilities to the total of the shareholders’ funds, ie C + D.
- This slide looks at why a balance sheet is produced (besides being a legal requirement) and identifies the stakeholders who would be interested. This is an introduction to the theme of the next chapter (3.25).
- This slide identifies the key aspects stakeholders would study – and why.