Understanding a

balance sheet

3 24.
Basic principles of a balance sheet

 Most businesses borrow money to help them

to operate.
 A balance sheet has a special section – called
liabilities. 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 must be accounted for in
another section, called assets.

3.24 Aims and Objectives Part 2

The key principle of a balance sheet

All assets must equal All liabilities

3.24 Aims and Objectives Part 2

What are assets? 1

Fixed assets are items owned by the company

which:
 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)

3.24 Aims and Objectives Part 2

What are assets? 2

Current assets include:

 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.

3.24 Aims and Objectives Part 2

What are liabilities? 1

Current liabilities are:

 Money the business owes to suppliers (called
creditors) for goods purchased on credit
 Short term loans

3.24 Aims and Objectives Part 2

What are liabilities? 2

Liabilities also 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.

3.24 Aims and Objectives Part 2

The structure of a profit and loss account 1 – Assets

Fixed assets £
Buildings 60,000
Equipment 20,000
Total fixed assets 80,000

Current assets
Stock 20,000
Debtors 10,000
Cash at bank 10,000
Total current assets 40,000
(Total assets = £120,000 but this figure doesn’t show)

3.24 Aims and Objectives Part 2

The structure of a profit and loss account 2 – Current liabilities

LIABILITIES
£
Current liabilities
Creditors -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)

3.24 Aims and Objectives Part 2

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)

3.24 Aims and Objectives Part 2

Putting it all together
ASSETS
Fixed assets (assets listed)
Total fixed assets £80,000
A
Current assets (assets listed)
Total current assets £40,000 B

LIABILITIES
Current liabilities –£10,000 C
Net current assets/liabilities £30,000 B–C
Total assets less current liabilities £110,000 A+B–C
Capital and reserves (all listed)
Shareholders’ funds £110,000 D

3.24 Aims and Objectives Part 2

‘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.

3.24 Aims and Objectives Part 2

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.

3.24 Aims and Objectives Part 2