BackBalance Sheets: Structure, Preparation, and Analysis
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Balance Sheets
Introduction to the Balance Sheet
The balance sheet, also known as the statement of financial position, is a key financial statement that presents the assets, liabilities, and capital of a business at a specific point in time. It provides a snapshot of the financial position of an entity, summarizing what it owns and owes, as well as the amount invested by the owners.
Assets: Resources owned by the business.
Liabilities: Obligations owed to outsiders.
Capital (Equity): The owner's claim on the assets after liabilities are settled.
The balance sheet is prepared using the balances remaining after the income statement has been completed. These balances are found in the accounting books and are not part of the income statement.
Purpose and Structure of the Balance Sheet
Purpose: To display the financial position of a business as at a specific date (e.g., 'as at 31 December 2019').
Structure: The balance sheet is organized into categories for clarity and comparability:
Non-current assets
Current assets
Current liabilities
Non-current liabilities
Capital (Equity)
Drawing Up a Balance Sheet
Example: B. Swift Balance Sheet as at 31 December 2019
The following is an example of a balance sheet layout, based on a post-income statement trial balance:
Assets | |
|---|---|
Fixtures and fittings | £5,000 |
Inventory | £3,000 |
Trade receivables | £6,800 |
Bank | £15,100 |
Cash | £200 |
Total assets | £30,100 |
Liabilities | |
Trade payables | £9,100 |
Net assets | £21,000 |
Capital | |
Capital | £21,000 |
Key Points in Preparing a Balance Sheet
Only accounts with balances after the income statement is prepared are included.
The balance sheet is not part of the double entry system; it is a listing of balances, not an account.
Assets and liabilities are categorized for clarity and comparability.
Categories in the Balance Sheet
Non-Current Assets
Non-current assets are assets that:
Were not bought primarily to be sold.
Are used in the business.
Are expected to be of use for a long time.
Examples: buildings, machinery, motor vehicles, fixtures and fittings. Non-current assets are listed in order of permanence (longest-held first).
Current Assets
Current assets are assets likely to change within twelve months. They are listed in order of liquidity (how quickly they can be converted to cash):
Inventory
Trade receivables
Bank
Cash
Trade receivables are often more liquid than inventory, as receivables can be factored (sold to a finance company).
Liabilities
Current liabilities: Obligations due within one year (e.g., trade payables, bank overdrafts).
Non-current liabilities: Obligations due after more than one year (e.g., bank loans, mortgages).
Capital (Equity)
The capital section shows the owner's investment and changes during the period, including:
Initial capital introduced
Add: Net profit for the year
Less: Drawings (amounts withdrawn by the owner)
Improved Balance Sheet Layout
A properly drawn up balance sheet separates assets and liabilities into current and non-current categories, and details the calculation of capital. The position of non-current liabilities is after current liabilities.
Non-current assets | |
|---|---|
Fixtures and fittings | £5,000 |
Current assets | |
Inventory | £3,000 |
Trade receivables | £6,800 |
Bank | £15,100 |
Cash | £200 |
Total current assets | £25,100 |
Total assets | £30,100 |
Current liabilities | |
Trade payables | £9,100 |
Net assets | £21,000 |
Capital | |
Capital introduced | £20,000 |
Add: Net profit for the year | £8,000 |
Less: Drawings | (£7,000) |
Total capital | £21,000 |
Additional info: If non-current liabilities exist, they are shown after current liabilities and included in total liabilities.
Key Calculations
Net assets:
Net current assets (Working capital):
Capital (Equity):
Important Concepts and Terms
Balance Sheet Date: The balance sheet is prepared 'as at' a specific date, showing the financial position at that moment.
Income Statement Date: The income statement covers a period (e.g., 'for the year ending 31 December 2019').
Double Entry System: The balance sheet is not part of the double entry system; it is a summary statement, not an account.
Liquidity: The order in which current assets are listed reflects their liquidity (ease of conversion to cash).
Comparability: Consistent layout allows users (e.g., managers, investors, creditors) to compare financial positions across businesses.
Summary Table: Balance Sheet Categories
Category | Examples | Order in Balance Sheet |
|---|---|---|
Non-current assets | Land, buildings, machinery, fixtures | First |
Current assets | Inventory, receivables, bank, cash | Second |
Current liabilities | Trade payables, overdrafts | Third |
Non-current liabilities | Loans, mortgages | Fourth (if any) |
Capital (Equity) | Owner's capital, retained profits | Last |
Practice Example
Given the following information, prepare a balance sheet as at 31 July 2024 for T. Smith:
Freehold premises: £160,000
Mortgage loan: £120,000
Inventory: £50,000
Trade receivables: £4,000
Cash and bank balances: £8,300
Trade payables: £14,000
Drawings: £25,000
Additional capital introduced: £8,000
Steps:
List non-current assets (e.g., freehold premises).
List current assets (inventory, receivables, cash/bank).
List current liabilities (trade payables).
List non-current liabilities (mortgage loan).
Calculate net assets and reconcile with capital (including profit and drawings).
Learning Outcomes
Understand the structure and purpose of the balance sheet.
Distinguish between current and non-current assets and liabilities.
Prepare a balance sheet from a trial balance after the income statement is completed.
Recognize the importance of net current assets (working capital).
Appreciate the balance sheet's role in financial analysis and decision-making.
