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3.24
Understanding a balance sheet
3.24 Aims and Objectives Part 2
Basic principles of a balance sheet
Most businesses borrow money to help them to operate.
A balance sheet has a special section – called liabilities. This shows how much money has been borrowed or invested – and where it came from.
The term ‘balance’ means that all the money invested or borrowed must be accounted for in another section, called assets.
3.24 Aims and Objectives Part 2
The key principle of a balance sheet
All assets All liabilitiesmust equal
3.24 Aims and Objectives Part 2
What are assets? 1
last a long time, eg buildings, vehicles, computers
cost a lot of money
could be sold to increase capital (ie money owned by the business)
Fixed assets are items owned by the company which:
3.24 Aims and Objectives Part 2
What are assets? 2
Current assets include:
Items used and replaced regularly, eg raw materials or stock
Customers who owe money (called debtors) for goods they have bought
Money in the current bank account.
3.24 Aims and Objectives Part 2
What are liabilities? 1
Current liabilities are:
Money the business owes to suppliers (called creditors) for goods purchased on credit
Short term loans
3.24 Aims and Objectives Part 2
What are liabilities? 2
Liabilities also includes capital and reserves.
Share capital is money which shareholders have invested in the business
Reserves = profit from previous years which has been kept to finance future developments
Profit and loss account = money kept back from the current year’s profits.
3.24 Aims and Objectives Part 2
The structure of a profit and loss account 1 – Assets
Fixed assets £
Buildings 60,000
Equipment 20,000
Total fixed assets 80,000
Current assets
Stock 20,000
Debtors 10,000
Cash at bank 10,000
Total current assets 40,000
(Total assets = £120,000 but this figure doesn’t show)
3.24 Aims and Objectives Part 2
The structure of a profit and loss account 2 – Current liabilities
LIABILITIES
£
Current liabilities
Creditors -10,000
Net current assets/liabilities 30,000
(This is the current assets - £40,000 - minus the current liabilities)
Total assets less current liabilities 110,000
(This is the total assets - £120,000 - minus the current liabilities)
3.24 Aims and Objectives Part 2
The structure of a profit and loss account 3 – Capital and reserves
Capital and reserves £
Share capital 70,000
Reserves 30,000
Profit and loss account 10,000
Shareholders’ funds 110,000
(This is the total amount in capital and reserves. It must equal the same amount as the total assets minus current liabilities)
3.24 Aims and Objectives Part 2
Putting it all together
ASSETS
Fixed assets (assets listed)
Total fixed assets £80,000A
Current assets (assets listed)
Total current assets £40,000 B
LIABILITIES
Current liabilities –£10,000 C
Net current assets/liabilities £30,000 B – C
Total assets less current liabilities £110,000 A + B – C
Capital and reserves (all listed)
Shareholders’ funds £110,000 D
3.24 Aims and Objectives Part 2
‘Reading’ a balance sheet
Both the balance sheet and the profit and loss account show the ‘health’ of the business
Shareholders, customers, suppliers, employees and other groups of people will be interested in both types of account.
3.24 Aims and Objectives Part 2
Key aspects on a balance sheet
Fixed assets – is there enough money secured in items which could be sold to raise capital?
Cash in bank – is there enough to cover a short-term crisis?
Net current assets/liabilities – if this figure is negative, the business hasn’t enough money to pay all the creditors in a reasonable time
Shareholders’ funds – are these increasing? Shareholders want their investment to grow.
