The balance sheet, along with the income statement is prepared at the end of the financial year. It shows the value of a business’ assets and liabilities at a particular time. It is also known as ‘statement of financial position’.
Assets are those items of value owned by the business.
- Fixed/non-current assets (buildings, vehicles, equipment etc.) are assets that remain in the business for more than a year – their values fall over time in a process called depreciation every year.
- Short-term/current assets (inventory, trade receivables (debts from customers), cash etc) are owned only for a very short time.
- There can also intangible (cannot be touched or felt) non-current assets like copyrights and patents that add value to the business.
Liabilities are the debts owed by the business to its creditors.
- Long-term/non-current liabilities (loans, debentures etc.)- they do not have to be repaid within a year.
- Short-term/current liabilities (trade payables (to suppliers), overdraft etc.)- these need to be repaid within a year.
CURRENT ASSETS – CURRENT LIABILITIES = WORKING CAPITAL
This is because the liquid cash a company has with them will be the liquid (short-term) assets they own less the short-term debts they have to pay.
Shareholder’s Equity is the total amount of money invested in the company by shareholders. This will include both the share capital (invested directly by shareholders) and reserves (retained earnings reserve, general reserve etc.).
Shareholders can see if their stake in the business has risen or fallen by looking at the total equity figure on the balance sheet.
Check whether the equations on the right are satisfied in this balance sheet!
SHAREHOLDERS EQUITY = TOTAL ASSETS – TOTAL LIABILITIES
TOTAL ASSETS = TOTAL LIABILITIES + SHAREHOLDERS EQUITY
CAPITAL EMPLOYED = SHAREHOLDERS EQUITY + NON-CURRENT LIABILITIES
This is because non-current liabilities like loans are also used for permanent investment in the company.
Uses of a statement of financial position
- When the current assets subtotal is compared to the current liabilities subtotal, investors can estimate whether a firm has access to sufficient funds in the short term to pay off its short-term obligations i.e., whether it is liquid
- One can also compare the total amount of debt (liabilities) to the total amount of equity listed on the balance sheet, to see if the resulting debt-equity ratio indicates a dangerously high level of borrowing. This information is especially useful for lenders and creditors, (especially banks) who want to know if the firm will be able to pay back its debt
- Investors like to examine the amount of cash on the balance sheet to see if there is enough available to pay them a dividend
- Managers can examine its balance sheet to see if there are any assets that could potentially be sold off without harming the underlying business. For example, they can compare the reported inventory assets to the sales to derive an inventory turnover level, which can indicate the presence of excess inventory, so they will sell off the excess inventory to raise finance
Notes submitted by Lintha
Click here to go to the next topic
Click here to go back to the previous topic
Click here to go back to the Business Studies menu