2.2 Balance sheet
Unlike the profit and loss statement, which focuses on a specific period of time, the balance sheet is a projection of assets, liabilities and equity at a specific point in time. As depicted in Table 3, the balance sheet summarises the financial situation of the business at, for example, a month end or the year end. The net worth must equal assets minus liabilities and ownership equity.
| SUMMARY BALANCE SHEET as at 31 December 2016 | ||
|---|---|---|
| £ | £ | |
| Fixed assets | ||
| Tangible assets | 45,000 | |
| Investments | 20,000 | |
| 65,000 | ||
| Current assets | ||
| Stocks | 980,000 | |
| Debtors | 1,410,000 | |
| Cash at bank and in hand | 110,000 | |
| 2,500,000 | ||
| Total assets | 2,565,000 | |
| Creditors: amounts falling due within a year | (2,200,000) | |
| Net current liabilities | 300,000 | |
| Total assets less current liabilities | 365,000 | |
| Capital and reserves | ||
| Owners share capital | 1,000 | |
| Profit and loss account, including £150,000 for | ||
| year end 31 Dec 2016 | 364,000 | |
| 365,000 | ||
Let’s turn to assets first. The first area to look out for is fixed assets. These include things like computers, furniture, stock and other physical items. Current assets – also referred to as short-term assets – comprise things such as cash in the bank and in hand, money in the till and anything you are owed (i.e. your debtors). In contrast to fixed assets, current assets can include any assets that will be converted into cash within one year from the date shown in the heading of the company’s balance sheet.
Now let’s turn to liabilities – the amount that your business owes to other entities. Creditors means the amount of money you must pay out over the coming year, such as office lease and loan repayments. Accrued liabilities are expenses incurred but not paid for, such as products, services and wages. Liabilities also include tax owed, such as company tax and employment-related taxes that need to be paid within a given timeframe.
The Financial Statements Explained in One Minute video introduced the notions of assets (such as cash in the bank, inventory or real estate) and liabilities (such as debt to suppliers). Subtracting liabilities from assets shows you the net worth (or equity) of your business.
Going beyond the video, you can consider the working capital. For this purpose, you may have a look at Table 3. The working capital is the difference between current assets [Tip: hold Ctrl and click a link to open it in a new tab. (Hide tip)] (such as cash, accounts receivable (i.e. customers’ unpaid bills) and inventories of raw materials and finished goods) and current liabilities (such as accounts payable).
The net worth (or owner’s equity, sometimes also referred to as net assets) is calculated from the total assets minus the total liabilities. It includes the share capital and retained profit or loss. If this figure is positive then the business is financially healthy. If it is negative the business is insolvent and extra funds are needed (Blundel et al., 2017).
Activity 3 will help you to prepare a balance sheet for your own business and reflect on its financial health.
Activity 3 Preparing a balance sheet
Produce a balance sheet that projects your business’s assets, liabilities and owner’s equity at a specific point in time. Use the sample balance sheet shown in Table 3 to help you.
Looking at your balance sheet, is your business financially healthy?
Discussion
Did you find this exercise easy or difficult to do? Are there still elements of the balance sheet that you don’t fully understand?
As a starting point, you should have used any available numbers referring to your own business and inserted them into an Excel spreadsheet that looks like Table 3. The video has shown how you can calculate the net worth (or equity) of your enterprise. This provides a snapshot of your business. Using the notion of working capital, you can gain even more insights into the financial health of your business.
2.1 Profit and loss statement