Balance Sheet is a snapshot of the business’s financial position on the particular date when Balance Sheet was prepared. It is an accounting statement that records the assets, liabilities and owners’ equity of a business at a particular date at a certain point in time.
Commonly, the main parts of Balance Sheet include three sections. Each of those sections include different data:
- Assets. Assets are resources that are owned by the business.
- Liabilities. Liabilities are debts of the business that will have to be paid sometime in the future.
- Equity. Equity is the wealth of the business.
It is common practice, and a legal requirement in many countries, to report the balance sheet figures for two consecutive years. This allows different stakeholder groups to make comparisons regarding the performance of the business.
The content of Balance Sheet is laid down by specific regulatory bodies in each country. But, it can be easily assumed that there will not be much differences between Balance Sheets regardless of the country where the business operates.
1. Assets
Assets are all resources which a business owns. They are items of monetary value that belong to the business. Assets can be divided and classified into Current Assets and Fixed Assets. To purchase all those assets, firms need different sources of finance.
Total Assets = Current Assets + Fixed Assets
Current Assets
Current Assets are cash and any other liquid assets that are likely to be turned into cash within the next 12 months, or the date of the next Balance Sheet. Current Assets are an important source of liquidity for the business to keep the business running on daily basis.
Examples of Current Assets:
- Cash. This includes cash in hand and cash in the corporate bank account.
- Debtors (Accounts Receivable). These include money owed to the business by customers who have bought products on credit. There were given trade credit, or have paid by cheque or credit card.
- Inventories. This is value of all unsold stock hold. Inventories include raw materials, work in progress and finished goods ready to be shipped to customers.
Fixed Assets
Fixed Assets are also called Non-Current Assets. These are all tangible assets having a physical existence. Fixed Assets are kept and used by the business for more than one year from the Balance Sheet date. They are used for long-term business operations. They are not intended for resale, but are used to generate output and sales of products.
Examples of Fixed Assets:
- Premises (Land & Buildings). These include physical land plots, buildings, office space, shops, restaurants, etc.
- Equipment (Machinery). This includes machines, tools, furniture, cash registers, computers, various IT equipment, etc.
- Vehicles. These include cars, trucks and any other motor vehicles used in the production process and for delivering products to customers.
Intangible Assets
Intangible Assets are identifiable items that do not have a physical presence but still have value in the business. These items make up for what is known as the ‘intellectual capital’ of the firm. They can give a business a greater market value than the total value of its tangible assets less its liabilities. Intangible Assets are especially important for an IT-based or knowledge-based businesses.
Examples of Intangible Assets:
- Brand. This includes a name, term, design, symbol or any other feature that identifies one seller’s good or service as distinct from those of other sellers.
- Patents. These are a type of intellectual property that gives its owner the legal right to exclude others from making, using or selling an invention for a limited period of years.
- Trademarks. These are a type of intellectual property consisting of a recognizable sign, design or expression which identifies products or services of a particular source from those of others.
- Copyright. This is a type of intellectual property that gives its owner the exclusive right to copy and distribute a creative work in a literary, artistic, educational or musical form.
- Goodwill. This is the established reputation of a business. It is represented by the excess of the price paid for a company over its fair market value at a sale, takeover, transference, exchange, etc.
2. Liabilities
Liabilities are the amounts of money owed by a business to others. They are legal obligations of a business to repay. Liabilities are divided and classified Current Liabilities and Long-term Liabilities.
Total Liabilities = Current Liabilities + Long-term Liabilities
Current Liabilities
Current Liabilities are all debts of the business that have to be paid back within the next 12 months, or the date of the next Balance Sheet. Current Liabilities along with Current Assets are an important source of liquidity for the business to keep the business running on daily basis.
Examples of Current Liabilities:
- Overdraft. This is the obligation payable back to the bank within the current accounting period. Overdraft carries high interest.
- Creditors (Accounts Payable). These include the amount of money a business owes to its suppliers for goods it bought on credit. Suppliers gave the business trade credit.
- Short-term Loan. This includes the amount of short-term debt as any bank loans that were given to the business for a period of time 12 months or shorter. Usually, a line of credit appears here.
- TAX. This includes any amount of TAXes owed to the government by the business. The actual amount of TAX can be seen in the Profit and Loss Account section of Profit and Loss Account (P&L Account). TAXes are usually paid once a year.
- Dividends. These include any unpaid dividends to shareholders, usually paid quarterly or sometimes monthly.
Long-term Liabilities
Long-term Liabilities are also called Non-Current Liabilities. These are the long-term loans owed by the business. They are sources of long-term borrowing. Long-term Liabilities are repayable after 12 months from the Balance Sheet date. They are mainly used for paying for Fixed Assets to ensure long-term business operations – producing output and selling products.
Examples of Long-term Liabilities:
- Mortgage. This special type of bank loan called mortgage is specifically used to buy Premises (Land & Buildings).
- Long-term Loan. The outstanding long-term bank loans are mainly used to purchase the Machinery (Equipment) for the production process.
- Debentures. These bonds are liabilities of the company because they represent debts that must be repaid in the future.
Working Capital
Working Capital is also called Net Current Assets. It is calculated as the difference between a firm’s Current Assets and its Current Liabilities. Working Capital is calculated using the following formula:
Working Capital = Current Assets – Current Liabilities
Net Assets
This is the sum of Total Assets minus Total Liabilities. It must match, or balance with, the firm’s equity. The value of a firm’s Net Assets is therefore the value of all assets minus all liabilities. Net Assets are calculated using the following formulae:
Net Assets = Equity
or:
Net Assets = Total Assets – Total Liabilities
or:
Net Assets = Fixed Assets + Current Assets – Current Liabilities – Long-term Liabilities
or:
Net Assets = Fixed Assets + Working capital – Long-term Liabilities
3. Equity
Equity is the amount of money that has been invested in the business by the owners. The owners’ equity, or shareholders’ funds, shows the capital and reserves of the business – all the money that belongs to its owners. This represents the money brought into the business by the owners when the shareholders bought shares plus any retained earnings of the business that the shareholders have accepted should be kept in the business. It is the permanent capital of the business which does not need to be repaid to shareholders, unlike loans that are repaid to creditors.
There are two main sections to this part of Balance Sheet:
- Share Capital. It is also referred to as Capital. This is the amount of money raised through the sale of shares. It shows the value raised when the shares were first sold to investors. If 1,000 shares were issued at USD$10, then the firm raised USD$10,000 as Share Capital. Note that this is not the current market price of the shares.
- Retained Profit. It is also referred to as Reserves. This is the amount of Net Profit After Interest and TAX after Dividends have been paid out. It is then reinvested in the business for its own use. This money belongs to its owners so it appears under Equity. The number for Retained Profit comes from the firm’s Profit and Loss Account (P&L Account). It is the surplus appropriated to the company from the previous year.
NOTE! Retained Profit, or Reserves, on Balance Sheet does not means ‘cash reserves’. It is because Retained Profit arises due to profits being made that are not paid as TAX or paid out as Dividends. But, they have nearly always been invested back into the business by being used to purchase additional assets. Therefore, they are no longer available as a source of liquid funds. The only liquid money available in the business are those indicated as Cash under Current Assets.
Equity is calculated using the following formula:
Equity = Total Assets – Total Liabilities
or:
Equity = Fixed Assets + Working capital – Long-term Liabilities
This means that the owners own the value of the assets of the business after deductions have been made for all its debts.
Equity is also called shareholders’ equity (for limited liability companies) or owners’ equity (for businesses other than limited liability companies).
Capital Employed
Capital Employed shows the value of all the money invested in the business for a long period of time. It includes Long-term Liabilities and Equity, specifically Long-term Liabilities plus Share Capital and Retained Profit. Capital Employed is calculated using the following formula:
Capital Employed = Long-term Liabilities + Share Capital + Retained Profit
In general, the value of Long-term Liabilities compared to the total Capital Employed by the business is a very important measure of the degree of risk being taken by the company’s management. The higher the percentage of Long-term Liabilities in Capital Employed, the riskier the business is. The lower the percentage of Long-term Liabilities in Capital Employed, the safer the business is.
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Here is the complete Balance Sheet for our famous hamburger restaurant. It shows the layout and main parts of a limited company’s Balance Sheet.
In summary, according to the law, limited companies must produce Balance Sheet at the end of every fiscal year. Other types of unincorporated businesses often choose to produce Balance Sheet at the end of their financial year. As it provides useful information about the business for both Internal Stakeholders and External Stakeholders.
