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 liabilities must 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 £ Buildings60,000 Equipment20,000 Total fixed assets80,000 Current assets Stock20,000 Debtors10,000 Cash at bank10,000 Total current assets40,000 (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/liabilities30,000 (This is the current assets - £40,000 - minus the current liabilities) Total assets less current liabilities110,000 (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 capital70,000 Reserves30,000 Profit and loss account10,000 Shareholders’ funds110,000 (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£40,000B LIABILITIES Current liabilities –£10,000C Net current assets/liabilities£30,000B – C Total assets less current liabilities£110,000A + B – C Capital and reserves(all listed) Shareholders’ funds£110,000D

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.