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Understanding a balance sheet
Lesson Objective
Understand the main elements of a balance sheet.
Understand the difference between assets and liabilities.
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Basic principles of a balance sheet
Most businesses borrow money to help them to operate.
A balance sheet has a special section – called Sources of Funds. 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 (Sources of Funds) must be accounted for in another section, called Net assets
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What are assets?
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) You will keep them for more than 12 months
Fixed assets are items owned by the company which:
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What are assets?
Current assets include: Assets for LESS than 12 months Assets which can be turned to cash easily and
quickly 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.
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What are liabilities?
Current liabilities are: Debts that will be paid within 12 months Money the business owes to suppliers (called
creditors) for goods purchased on credit Short term loans Examples: Overdraft, tax, dividends
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What are Sources of Funds?
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.
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The key principle of a balance sheet
Sources of Funds
Net Assets
must equal
Long term liabilities
Plus reserves
Plus Share capital
Fixed assets
Plus
Current assets
Less current liabilities
Working Capital
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The structure of a profit and loss account 1 – Assets
Fixed assets £Buildings 60,000
Equipment 20,000
Total fixed assets 80,000
Current assetsStock 20,000Debtors 10,000Cash at bank 10,000Total current assets 40,000(Total assets = £120,000 but this figure doesn’t show)
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The structure of a profit and loss account 2 – Current liabilities
LIABILITIES£
Current liabilitiesCreditors -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)
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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)
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Putting it all together
ASSETSFixed assets (assets listed)Total fixed assets £80,000 ACurrent assets (assets listed)Total current assets £40,000 B
LIABILITIESCurrent liabilities –£10,000 C
Net current assets/liabilities £30,000 B – C
Total assets less current liabilities £110,000 A + B – CCapital and reserves (all listed)Shareholders’ funds £110,000 D
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‘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.
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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.
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Complete Work sheets
Lesson Objective
Understand the main elements of a balance sheet.
Understand the difference between assets and liabilities.
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