1. Understanding and Managing Finance Presentation 4 Brief Version

2. Learning Outcomes  Understand the role and limitations of the Balance Sheet as a summary of the financial position of a business.  Be able to work with a Balance Sheet in different formats  Be able to work out the effect of business transactions on a Balance Sheet.  Be able to discuss some of the Accounting Conventions associated with Balance Sheets

3. Financial Terms  Income – An amount of money which comes in to, or is earned by, the business during an accounting period - sometimes called Revenue.  Expenditure – An amount of money which has been spent by, or goes out from, the business during an accounting period.

4. Assets Major characteristics A probable future benefit exists The business has an exclusive right to control the benefit The benefit must arise from some past transaction or event The asset must be capable of measurement in monetary terms Assets are items of value owned by the business. In accounting terms, the term ‘assets’ has a very narrow meaning, defined by these four characteristics: Read p 29 of M & A for further explanation.

5. Claims Two major types of claim Capital Liabilities Claims are obligations on the business to give cash or benefit to some external party.

6. Claims Claims are what a business ‘owes’. There are two forms of claims: 1.Capital: This is the owner’s (shareholders’) investment in the business. 2.Liabilities: These are claims on the business made by external individuals and organisations, and include:  Trade Creditors  Bank and other Loans  Unpaid Tax

7. Balance Sheets In Horizontal Format This method is the easiest to understand, as the ‘balance’ figure can be seen at once. Balance Sheet Layout (Horizontal Format) Fixed Assets Capital & Reserves + + Current Assets Long-term Liabilities+ Current Liabilities Total Assets Total Claims BALANCE

8. The balance sheet equation for Horizontal Format Balance Sheets equals Liabilities Assets Capital plus Left Hand SideRight Hand Side

9. Sample Balance Sheet (Horizontal format) Fixed AssetsCapital & Reserves Land£ 120,000Share capital £ 100,000 Buildings£ 150,000Retained profit£ 120,000 Fix & Fit£ 75,000 Total£ 220,000 Total£ 345,000L/T Liabilities Loan£ 250,000 Current AssetsTotal£ 250,000 Stock£ 55,000Current Liabilities Debtors£ 75,000Creditors£ 22,000 Bank£ 25,000Tax & VAT£ 8,000 Total£ 155,000Total£ 30,000________£ 500,000 The two bottom lines Balance

10. Recording Transactions  Last week we saw how different transactions affected the double entry pages on the spreadsheet  This week we examine the effects of transactions on the Balance Sheet  As last week each transaction will have two effects: »One which increases the wealth of the business »One which decreases the wealth of the business  The net effect will be zero.

11. Transaction 1 Fixed AssetsCapital & Reserves Land£ 120,000Share capital £ 100,000 Buildings£ 150,000Retained profit£ 120,000 Fix & Fit£ 75,000 Total£ 220,000 Total£ 345,000L/T Liabilities Loan£ 250,000 Current AssetsTotal£ 250,000 Stock£ 58,000Current Liabilities Debtors£ 75,000Creditors£ 22,000 Bank£ 22,000Tax & VAT£ 8,000 Total£ 155,000Total£ 30,000________£ 500,000 Stock is bought for £3000 Cash Net Effect : Stock Increases by £3000 Cash Reduces by £3000 No Change in Balances

12. Transaction 2 Fixed AssetsCapital & Reserves Land£ 120,000Share capital £ 100,000 Buildings£ 150,000Retained profit£ 120,000 Fix & Fit£ 75,000 Total£ 220,000 Total£ 345,000L/T Liabilities Loan£ 250,000 Current AssetsTotal£ 250,000 Stock£ 58,000Current Liabilities Debtors£ 75,000Creditors£ 22,000 Bank£ 17,000Tax & VAT£ 3,000 Total£ 150,000Total£ 25,000________£ 495,000 A Tax Bill of £5,000 is paid Net Effect : Cash reduces by £5000 Tax Reduces by £5000 Both Balances change by the same amount

13. Transaction 3 Fixed AssetsCapital & Reserves Land£ 120,000Share capital £ 100,000 Buildings£ 150,000Retained profit£ 123,000 Fix & Fit£ 75,000 Total£ 223,000 Total£ 345,000L/T Liabilities Loan£ 250,000 Current AssetsTotal£ 250,000 Stock£ 56,000Current Liabilities Debtors£ 75,000Creditors£ 22,000 Bank£ 22,000Tax & VAT£ 3,000 Total£ 153,000Total£ 25,000________£ 498,000 Stock worth £2000 sold for £5000 Net Effect : Cash increases by £5000 Stock Reduces by £2000 Profit Increases By £3000 Both Balances change by the same amount

14. Vertical Format Balance Sheets  Although the Horizontal Format for Balance Sheets is easy to understand, many companies prefer to use the Vertical Format.  This Balance sheet is divided into two parts: »The top part shows the Net Assets of the Company, that is, what the company owns when all debts and loans and outstanding tax bills etc. have been paid off. »The bottom part shows the Shareholders’ Claim; in other words, all the money that is invested in the company through share owning.

15. minus Capital Long-term liabilities Current assets less Current liabilities Fixed assets plus equals The Balance Sheet Equation for Vertical Layout Balance sheets

16. SAMPLE BALANCE SHEET (VERTICAL FORMAT) Fixed AssetsLand£ 120,000 Buildings£ 150,000 Fix & Fit£ 75,000 Total£ 345,000 Current AssetsStock£ 55,000 Debtors£ 75,000 Bank£ 25,000 Total£ 155,000 Current Liabilities Creditors£ 22,000 Tax & VAT£ 8,000 Total£ (30,000) Net Current Assets£ 125,000 Total Assets£ 470,000 Less Long term liabilities (Loan)£(250,000) £ 220,000 Capital & Reserves Share capital£ 100,000 Retained profit£ 120,000 £ 220,000

17. Summary of Balance Sheet Formats Horizontal Format Fixed Assets Capital & Reserves + + Current Assets = Long-term Liabilities + Current Liabilities Vertical Format Fixed Assets + Current Assets - Current Liabilities - Long term Liabilities = Capital & Reserves

18. Seminar Four - Activities (a) Multiple Choice Test 1 This concerns »Principles of Accounting (week 1) »Double Entry Bookkeeping (week 3) (b) Video: The Balance Sheet (c) You should also attempt Exercises 2.4 (M & A page 55) A detailed solution is at the back of the book. Exercises 2.6 (M & A page 55) Solutions will be available for this next week.