Balance sheet

Basic introduction of balance sheet

1. BALANCE SHEET 1

2. A Balance Sheet is one of the financial statements . A Balance Sheet is a statement of assets and liabilities of an enterprise at a given date. It is also called Statement of Financial Position. 2

3. Introduction Balance Sheet will summarizes the financial condition of the business at a point in time and it is described as a snapshot of a company . Balance Sheet shows the assets, liabilities and Equity at a certain time , usually at the end of a fiscal quarter or year . Balance sheet presents assets on left hand side and equity and liabilities on the right hand side . Some use Assets at the top and Equity and Liabilities at the bottom of the page but the concept is the same. 3

4. Features of Balance Sheet A balance sheet is only a statement and not an account . It has no debit side or credit side. The headings of the two sides are ‘Assets’ and ‘Liabilities’. It is prepared at a particular point of time and not for a particular period . The information contained in it is true only at the particular point of time at which it is prepared. It is a summary of balances of those ledger accounts which have not been closed by transfer to the Trading and P & L Account. It shows the nature and value of assets and the nature and the amount of liabilities at a given date. 4

5. Need of Balance Sheet To ascertain the nature and value of assets of a business. To ascertain the nature and amount of liabilities of a business. To find out the financial solvency of an enterprise. An enterprise is considered to be a solvent if its assets exceed its external liabilities. 5

6. 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 . 6

7. General Format of a Balance Sheet Assets Current assets $XXX Noncurrent assets XXX Total assets $XXX Liabilities Current liabilities $XXX Noncurrent liabilities XXX Total liabilities $XXX Owner’s equity XXX Total liabilities and owner’s equity $XXX 7

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10. What are Assets? last a long time e.g., buildings, vehicles, computers. cost a lot of money. could be sold to increase capital (i.e. money owned by the business). Fixed assets are items owned by the company which: 10

11. What are Assets? Current assets include: Items used and replaced regularly e.g., raw materials or stock. Customers who owe money (called debtors ) for goods they have bought. Money in the current bank account. 11

12. What are Liabilities? Current liabilities are: Money the business owes to suppliers (called creditors ) for goods purchased on credit. Short term loans. 12

13. What are Liabilities? 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. 13

14. Balance Sheet Analysis Used to measure the financial condition of the business (management tool): Compare to other, but similar businesses. Compare to the same business over time. Lenders use balance sheet analysis to make lending decisions and to monitor the financial progress of their customers. 14

15. 15 Balance Sheet Analysis A. Measures of Liquidity: Current Ratio Working Capital B. Measures of Solvency: Debt/Asset Ratio Equity/Asset Ratio Debt/Equity Ratio

16. The Concept of Liquidity Short-term measure. Measures the ability to meet financial obligations: As they come due. Without disturbing normal revenue generating activities. Ability of the firm to generate cash for running the business. 16

17. Measures of Liquidity Current Ratio: Total current farm assets ÷ Total current farm liabilities or CA/CL: Example from text: 112,500 ÷ 88,860 = 1.27 Write the Current Ratio as 1.27:1 Current assets compared to current liabilities. Values > 1 are preferred (safety margin). Larger ratios imply more liquidity. 17

18. Measures of Liquidity Working Capital: Total current farm assets - Total current farm liabilities: Example: $112,500 - $88,860 = $23,640 Working Capital as $23,640 $ left after selling all current assets and paying off all current liabilities. Margin of safety in a $ value. 18

19. The Concept of Solvency Measures the degree to which liabilities are backed up by assets. Measures liabilities relative to owner equity. Ability to pay off all liabilities if all assets were sold. 19

20. Measures of Solvency Debt/Asset Ratio: Total farm liabilities ÷ Total farm assets Example: $368,860 ÷ $741,500 = 0.4975 x 100 Debt/Asset Ratio as 49.75% % (share) of total assets owed to lenders. Lower values are preferred. 20

21. Measures of Solvency Equity/Asset Ratio: Total farm equity ÷ Total farm assets Example: $372,640 ÷ $741,500 = 0.5025 x 100 Equity/Asset Ratio as 50.25% % of total assets financed by owner’s equity capital. Higher values are preferred. 21

22. Measures of Solvency Debt/Equity Ratio (leverage ratio): Total farm liabilities ÷ Total farm equity Example: $368,860 ÷ $372,640 = 0.99 Debt to Equity Ratio as 0.99:1 Lender financing compared to owner financing. Smaller values are preferred. 22

23. 23 conclusion A balance sheet shows the financial position of a business at a point in time. Assets can be valued using cost methods or current market valuations. Liquidity measures the ability of the business to meet financial obligations as they come due and without disturbing normal production. Solvency measures the degree to which the liabilities of the business are backed up by its assets.

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