The Balance Sheet
Peter Marshall Bsc (Econ) BA MBIM is a Fellow of the Society of Business Teachers, and an experienced educator in business subjects. He is also a prolific author and his books have been translated and sold worldwide. He lives in London, UK.
A financial snapshot
We have already seen standard sorts of statement summarising particular aspects of the business. The bank reconciliation was an example. The balance sheet is another—but a much more important one. Unlike the trading, profit and loss account, the balance sheet is not an ‘account’ as such. Rather, it is a useful snapshot of the firm’s financial situation at a fixed point in time. It sets out clearly all the firm’s assets and liabilities, and shows how the resulting net assets are matched by the capital account.
The balance sheet always goes hand-in-hand with the trading, profit and loss account. We need it to show:
- where the net profit has gone (or how the net loss has been paid for)
- how any net profit has been added to the capital account
- how much has been taken out as ‘drawings’ and whether any of it has been used to buy new assets (stating what those assets are).
Accounting ratios can be worked out to help decision-making. For example the ratio of current assets/current liabilities shows how easily a firm can pay its debts as they become due (a ratio of 2/1 is often seen as acceptable in this respect). More will be said about these ratios later.
Five main components of the balance sheet
The balance sheet tells us about five main categories:
- 1.Fixed assets. These are assets the business intends to keep for a long time (at least for the year in question). They include things like premises, fixtures and fittings, machinery and motor vehicles. Fixed assets are not for using up in day to day production or trading (though a small part of their value is used up in wear and tear, and that is treated as an expense—‘depreciation’). Property should be valued at net realisable value or cost whichever is the lower.
- 2.Current assets. These are assets used up in day to day trading or production. They include such things as stock, debtors, cash at bank and cash in hand.
- 3.Current liabilities. These are amounts the business owes to creditors, and which usually have to be paid within the next accounting year. They include trade creditors, and bank overdraft.