The Balance Sheet is also known as a Statement of Financial Position (or Condition) or an Assets and Liabilities report.
Why is it important?
The Balance Sheet compares your business’s current assets to its liabilities. This shows you how much money is available to your shareholders. It also helps you work out whether you have enough money to pay your bills.
If you have investors, they may use it to gain insight into the business and its operations. They may also look at it to see if there is enough cash available to pay dividends or to invest more in the business.
Potential buyers may also look at the Balance Sheet to assess the state of the business.
You can also use the balance sheet to work out your 'liquidity ratio'. This tells you whether you have enough cash, money in the bank, or assets that can be quickly converted to cash to pay your bills. If you don’t, your business could hit difficulties and forced to stop trading.
The balance sheet shows you:
- a list of everything your business owns - your total assets
- a list of everything your business owes - your total liabilities
- the amount invested by your shareholders - your equity
It's called a balance sheet because each side must match the other.
Assets = Liabilities + Equity
Your assets must equal the total of your liabilities and equity. In other words, whatever assets aren’t used to pay off the liabilities belong to the shareholders.
This is also known as your liquidity or working capital. It tells you if you have enough cash, money in the bank, or assets that can be quickly converted to cash to pay your bills.
The formula for working this out is to divide your current assets by your current liabilities.
Greater than 1 = you can cover your debts.
Less than 1 = you could face short-term problems covering your debts.
- Your current assets = £120,000
- Your current liabilities = £60,000
- £120,000 / £60,000 = 2
Your current ratio is 2:1 so you can cover your debts.
What's on the report
Assets are the things your business owns, such as:
- The amount of money in the bank
- Any high value items you own such as property or company vehicles
- Money made from sales
Your assets are then split into two further groups.
These are things you only have for short time (usually less than a year) and can sell quickly.
- Cash or money in the bank
- Money owed to you by your customers. Also known as Trade Debtors, Debtors Control, or Accounts Receivable
- The value of any items you have in Stock, also known as Inventory
Inventory (Products and services) represent the business's raw materials and goods. The exact details of the products and services account will differ. Manufacturing businesses, for instance, will have a large stock of raw materials.
Retail businesses don't have any raw materials. Their inventory is typically made up of goods purchased from manufacturers and wholesalers.
These are things that you own for longer than a year and you cannot sell easily. They are on different sections on the balance sheet.
Most non-current assets will decline (depreciate) or increase (appreciate) in value over time. This value is also recorded on the balance sheet.
These are physical things that your own. Some examples include:
These are things that have value but are not physical. Some examples include:
Liabilities refer to the money that your business owes to others. This includes bank loans, your mortgage, money owed to your suppliers and money owed to the government in tax.
Liabilities are not always a bad thing. They only become a problem when your business consistently spends more than it earns and has no clear and viable strategy to reduce that trend.
These refer to money that you owe and need to pay back in the short term, usually less than a year.
Examples of current liabilities are:
- Bank loans and credit cards
- Money you owe your suppliers. Also known as Trade Creditors, Credit Control or Accounts Payable
- Money you owe the government for tax
These are liabilities which are due for payment more than a year from the date of the balance sheet.
Examples of long-term liabilities:
This is amount of money invested in the business. This can consist of:
- Profit and loss or Retained Earnings. This is the amount of profit (after tax) reinvested in the business at the end of the financial year and not distributed to shareholders
- Equity - the amount invested by shareholders or the business owner