The Balance Sheet

Definition

The Balance Sheet is a statement, reflecting the assets and liabilities of the business as at a specific date.

It is a "snapshot" taken of a business's state of affairs at a specific point in time reflecting what a business owns and owes on a specific date.

Owns = Assets = How money is used

Owes = Liabilities = Where money came from

Balance Sheet: What it tells you

The Balance Sheet highlights the financial strengths and/or weaknesses and the business's ability to meet its obligations as they fall due.

In order to understand how to balance the Balance Sheet, think of a typical scale with the Liabilities on the left side and the Assets on the right side. The Liabilities must equal the Assets in order to balance.

Balance Sheet: Tip!

There is a common misconception that Distributable Reserves represent money hidden away somewhere. This is not true as these funds are employed to acquire assets - i.e. It enables the company to purchase more stock (current assets) or new furniture (fixed assets).

Balance Sheet: Who uses it

The information obtained from the Balance Sheet is useful to:

• Users within the Business (Internal)
• Directors of companies
• Members of close corporations
• Partners of partnerships
• Owners/Sole Proprietors to manage their business effectively by analysing the information provided in the Balance Sheet.
• Users outside the Business (External)
• Shareholders - from an investors point of view, they would like to see the business managed in such a manner that the net worth will increase.
• Banks - to assess the worth of a business when applying for credit
• Receiver of Revenue - for tax purposes

Balance Sheet: Glossary of Terms

Capital Employed (Liabilities)

Capital is the name describing the funds used to set up a business.

It is calculated by adding together the totals of Issued Share Capital, Non Distributable Reserves,

Distributable Reserves and Long Term Liabilities

Share Capital

The most common ways for a company to raise capital is by selling shares in the company. The investors buying these shares are called Shareholders and are in effect all joint owners of the company. By investing in a company, investors expect a return in the form of dividends. This is normally a more profitable investment than ordinary savings and/or fixed deposit account.

However, there is a risk involved of losing money should the company be declared insolvent (bankrupt).

Profits or Reserves

The company can also accumulate funds through profits. If the profits are substantial, a portion, or all of it, is reinvested in the company.

Loans or Long Term Liabilities

A company can borrow money from banks, building societies or private concerns. This is known as Loan Capital.

Issued Share Capital

Under the heading Share Capital the value of authorised shares and the values of shares issued are listed.

Authorised Share Capital is the maximum number of share a company may issue

Issued Share Capital is the actual amount of shares issued. This amount may not exceed the authorised Share Capital

Unissued ShareCapital is the amount of shares the company wishes to withhold. They may decide, at a general meeting of the Directors, to sell these, if more capital is required.

Members Contribution

In the event of the business being a Close Corporation, there is no Share Capital. The amounts invest in the CC are known as the Members' Contribution.

Non-Distributable Reserves (Capital Reserves)

Non-distributable Reserves may not be used for distribution by way of dividends. It can also be called Capital Reserves which may be created in two ways:

i Profit earned from a source other than the normal means of business

Example: A Company disposes of a fixed asset (furniture) at a price greater than the depreciated value shown in the Balance Sheet (The notes will give details)

Furniture has been sold for £100.00

Furniture was depreciated to £ 10.00

Non distributable reserves £ 90.00 = A Capital Reserve

ii Re-Valuation of Fixed Assets

EG.
Net Book Value £100,000.00

Re-Valuation £110,000.00

Non Distributable Reserves £ 10,000.00

Distributable Reserves - Retained Income (Retained Profit)

A company has no profit when it first begins, only the ordinary Share Capital provided by the shareholders. A profit (or loss) can only be made after the company has been trading or rendering service for a period.

Retained Income (sometimes called unappropriated profit) is transferred from the Income Statement to the Balance Sheet as a distributable reserve.

These funds can be distributed to shareholders in the form of dividends, ie the shareholders will receive a share of the profits.

If a company makes a loss in any financial year, they may still wish to give the shareholders a dividend. They can use the retained income from previous years, that has been accumulated and held as Distributable Reserves.

Shareholders Interest (Shareholders Equity)

Shareholders Interest is obtained by adding the Share Capital, Non-distributable Reserves and the distributable reserves together.

It is the total of all funds invested in the company, by the shareholders, plus all the profits earned by the company that have been re-invested into the company.

Long Term Liabilities

A company can borrow money over a period longer than 12 months and such a borrowing becomes a long-term liability.

Employment of Capital

Employment of Capital is divided into 2 main sections:

Fixed Assets (and Other Assets) and

Working Capital (Current Assets - Current Liabilities)

Working Capital can be a negative value, if the current liabilities exceed the current assets.

Fixed Assets

Fixed Assets are those assets acquired with the intention to be held permanently.

Fixed Assets consists of a number of items of which Land and Buildings are amongst the most valuable fixed assets a company can own and are always shown at cost or market value in the Balance Sheet. Depreciation is usually not calculated and deducted from Buildings although some companies, where the Buildings are of a very specialised nature, will depreciate their property. Land however, never depreciates.

Other fixed assets such as plant, machinery, vehicles, equipment and furniture depreciate each year.

Depreciation is a cost, brought about by wear and tea, and is used as a method to reduce the value of an asset to its net realisable value.

The Receiver of Inland Revenue prescribes over what period assets are to be written off taking into consideration the estimated useful life of the asset concerned.

Other Assets

Investments

Long Term Investments (invested for longer than 12 months) are regarded as Other Assets

Goodwill/Cost of Control

Good will is an intangible value placed on a business' worth. The difference between the selling price and the net asset value of the business is called goodwill. This is an intangible and must be excluded for assessment purposes. It is worthless when granting credit as these values cannot be converted into cash.

Current Assets

Current Assets are acquired with the intention to resell or subsequently convert into cash within the next 12 months. The most common items found under Current Assets are :

Stock (Inventories)

Stock will be valued at cost or market value, which is the lowest. Stock can be in the form of Raw Materials, Work in Progress or Finished Goods. This is the Closing Stock figure from the Income Statement.

Debtors (Accounts Receivable)

People who owe the business money and are expected to pay their debt in the short term.

Associated Companies Loans (Subsidiary Companies or Directors)

These are inter-company lendings that must be repaid within 12 months (In a sense this is a debtor)

Cash/Bank

All cash on hand and in the Bank, including Investments invested for a period less than 12 months.

Short term investments may also appear under Accounts Receivable or Marketable Securities.

Taxation

Companies are required to estimate their annual pre-tax profits for the year and to pay it in advance. If the company over-estimate and pay too much tax, the amount to be refunded by the Receiver of Revenue is shown on the balance sheet as Taxation. The company will not be refunded immediately, but will have a credit account with the Receiver of Revenue equal to this amount.

Current Liabilities

These are all the monies owed by the Company, payable within the next 12 months.

The most common items found under Current Liabilities are:

Bank overdraft

A company may often make use of an overdraft facility. These overdraft facilities are reviewed annually and banks frequently require that overdrafts are completely repaid during the year.

Creditors (Accounts payable)

All amounts that the company owes to suppliers of goods or services which is to be paid within the next 12 months.

Taxation owing (Provision for tax)

This figure represents an accrued expense, eg. Taxes due to the Receiver of Revenue, but not yet paid at Balance Sheet date.

Current Maturities (Hire Purchase or Suspensive Sale)

Repayments on Instalment Sale, Rental and Lease agreements and bond repayments payable within the following 12 months.

Amounts owing to affiliated Companies (Subsidiaries + Directors)

Inter-company borrowings payable in the next 12 months.

Dividends Proposed (Declared Dividends)

Amounts set aside for Dividends, because although a dividend has been declared, it is still unpaid on Balance Sheet date.

Net Current Assets (Liabilities)

This amount is the difference between the Current Assets and the Current Liabilities (called Working Capital if it is a positive figure). This is an important aspect as it determines a company's ability to cover short term debts.