How it works
The balance sheet essentially
shows what the company owns,
what it owes, and how much is
invested in it. It is based on the
accounting formula, sometimes
called the balance-sheet equation,
which is the basis of double-entry
bookkeeping. This shows the
relationship between assets,
liabilities, and owners’ capital—
what the company owns (assets)
is purchased either through debt
(liability) or investment (capital).
The equation always balances, as
everything a company owns has to
have been bought with its owner’s
funds or through borrowing.
Balance sheet
A balance sheet is a financial statement that shows what a business is
worth at a specific point in time. Its primary purpose is to show assets,
liabilities, and equity (capital), rather than financial results.
Deferred income Income a
company receives for goods
or services that have not yet
been delivered or provided. Until
income is received it is recorded
on a balance sheet as a liability.
NEED TO KNOW
The balance-sheet equation
As the name suggests, the balance sheet must always balance. This is
because everything the business owns (its assets) must be offset against
the equivalent capital (or equity) and liabilities (debt).
ASSETS
$1,000
ASSETS
$1,000
CAPITAL
$600
LIABILITY
$400
LIABILITY
$0
CAPITAL
$1,000
Company incurs $400
in liabilities
After spending $400 on, for example,
an illuminated sign for the storefront,
the owner incurs $400 in liabilities and
so the formula changes. However, since
the sign is worth $400, and the owner
has $600 remaining, the equation
remains balanced—as it always does.
Company has no liabilities
For example, a young business may
have assets of $1,000. It currently has
no liabilities so its capital is equal to
its assets—that is, it is the amount of
equity the owners or shareholders
have invested in the business. Using
the accounting formula, the equation
would look like this:
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HOW FINANCE WORKS
Financial accounting
Case study: balance sheet
This example from Wessex Water, a UK public utility company, shows how a balance
sheet works in practice (at the time, the exchange rate was £1 = $1.58).
Fixed assets
Tangible assets 2,167.1 2,069.2
Investments – –
Current assets
Stock and work in progress 7.0 6.3
Debtors 162.6 153.9
Cash in the bank and in hand 181.0 211.0
350.6 371.2
Creditors—amounts falling due within one year (198.8) (171.7)
Creditors—amounts falling due after more (1,891.5) (1,811.9)
than one year
Provisions for liabilities and charges (114.9) (115.3)
Retirement benefit obligations (93.1) (83.0)
Deferred income (17.2) (17.9)
Capital and reserves
Called-up equity share capital 81.3 81.3
Profit-and-loss account 120.9 159.3
Net assets 202.2 240.6
Shareholders’ funds 202.2 240.6
Net current assets 151.8 199.5
Total assets less current liabilities 2,318.9 2,268.7
Current assets are assets that last
one year or less, and can be easily
converted into cash. Cash, cash
equivalents, and inventory are
the most common current assets
Creditors are the individuals or
organizations to which the company
owes money. Here, the money must
be repaid in the current financial year
Net current assets equal current
assets after money due to creditors
within one year has been deducted
Total assets less current liabilities
is the sum of fixed and net current
assets minus liabilities due within the
current financial year
Fixed assets (or non-current assets)
are not easily converted into cash
and usually last longer than one
year. They are either tangible, such
as land, or intangible, such as a logo
Net assets are what is left once
liabilities have been deducted from
the company’s fixed and net current
assets to give the overall net assets
Shareholders’ funds, or owner’s
equity, is the remaining capital;
this money can be reinvested
into the business or paid out as
an annual dividend
Year 2013
£m
Year 2012
£m
ASSETS, LIABILITIES, AND CAPITAL
Liabilities due in more than one
year are amounts due to creditors,
which are deducted from total fixed
and net current assets
SYMBOLS FOR DEBITS AND CREDITS
Accountants use a number of different terms and symbols to indicate debits and credits.
Some use “Dr” for debits and “Cr” for credits, others use “+” for debits and “–” for credits.
On this balance sheet, parentheses are used to show credits (negative numbers).
$
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