The Balance Sheet is a fundamental component of a company’s financial statements. It is a summary of all the assets and liabilities of a business at a given point in time, typically a year or month end. Unlike the Profit and Loss Account (P&L), the Balance Sheet is not a summary of transactions between two dates, but rather the culmination of everything that has ever happened in the business up to the date it is prepared.
The Balance Sheet can be prepared in a number of different ways, in order to meet the statutory requirements of the accounting standards to which the company reports i.e. a private company and a public company have slightly different formats. However, there are common elements typically grouped into the following sections:
Also known as Non-Current Assets, these are things that your company owns and will continue to use in the business over a number of years – such as buildings; machinery; cars; or computers. As well as being tangible items, they may also be intangible items such as goodwill (this is a ‘book entry’, arising from any premium paid in a business purchase).
Fixed assets are held on the Balance Sheet, rather than going to the P&L because their value is not consumed by the business in a single period (therefore putting the whole cost of, say, a building in the P&L in the year of purchase would be unrepresentative of how the building will be consumed by a business). There is a mechanism to drip feed the costs of the asset to the P&L over the period where the asset is used by a business: this is called depreciation. Another book entry, depreciation is used to reduce the value of the asset on the Balance Sheet and recognise a proportion of the cost in the P&L each period.
Like Fixed Assets, these are items the business holds for its benefit and typically includes: any cash balance; any unpaid sales invoices (commonly known as debtors or receivables); stock; items where we have paid in advance for something but not yet used it all (‘prepayments’); and any other items which will bring an inflow of cash in the future – such as a rent deposit (at some point in the future it will be repaid and so is not a cost).
Essentially the opposite of current assets. These are items where the business typically owes money to someone else, such as: unpaid purchase invoices; loans and overdrafts; tax (including PAYE and VAT); accruals (items where we have used a product or service but have not yet been billed for it); and income or deposits we have received in advance of providing the service. Current liabilities are items that will be paid within 12 months.
The definition of liability is the same as above, however ‘non-current’ indicates due in more than 12 months from the Balance Sheet date. Typically loans that will be repaid over a few years, with the portion that is not due in the next year categorised here.
Equity is the difference between the assets and liabilities and is the “paper” or “net book value” of a company. It comprises the share capital and premium that shareholders have committed to the business, as well as all the profits the business has made and retained in the company, rather than pay out the shareholders as dividends.
Equity is the difference between the assets and liabilities and is the “paper” or “net book value” of a company
Equity can also be negative if the business has made losses and has been funded by loans. This is termed being Balance Sheet insolvent; and it is not possible to pay a dividend to shareholders unless there is positive equity.
How to use a Balance Sheet
The Balance Sheet, although only a snapshot in time, is a very useful tool for assessing the financial position of a business.
It can be used to understand its working capital requirements or liquidity; and can be used, very powerfully, in conjunction with the P&L to understand how well the capital is being put to use by the Directors and to identify efficiency issues such as slow debtor collection or inefficient stock management.