The Balance Sheet: What is it…?

You receive a balance sheet along with your profit and loss statement every year from your accountant.

You understand what your profit and loss statement means, but honestly, what the hell is the balance sheet?

Does it matter? Does it mean anything?

It’s actually more important than the profit and loss…

Let me explain.

Your balance sheet explains the financial position of your company on a given date. This date is usually the 31st of March, the last day of the tax year.

But a balance sheet can be prepared for any day of the year. It’s a snapshot of the businesses financial standing.

It also tells an outsider everything they need to know about a business.

It shows the cash movement compared to a previous period, and it also shows how much profit or loss the company made in the last financial year.

So yes, it’s very important.

An easy way to think about it, is in the context of a home. It’s the same thing.

A home (normally) has a purchase price, a mortgage, and the remainder, which is equity. That’s the exact same for a company’s balance sheet. It has assets (value of the home), liabilities (mortgage), and equity (the difference between the two).

The main difference between your home balance sheet and company, is that you normally know the value of your home. Where as the assets on your company balance sheet are usually recorded at cost, rather than current market value.

You therefore know the value of the equity you have in your home (market value less mortgage debt).

For your company, an easy way to calculate the value of the equity is to take the market value of your business and subtract and liabilities.

Let’s dig a little bit deeper. What do the headings on the balance sheet mean?

Current Assets

These are the assets the company expects to collect in the next twelve months.

These would include the company’s bank accounts, accounts receivable, any inventory or stock on hand, and other short term financial amounts that are owed or owned by the company.

Non-Current Assets

These are assets that are expected to be realised by the company in more than 12 months.

For instance, fixed assets; motor vehicles, machinery, intellectual property, property investments.

Current Liabilities

Just with current assets, current liabilities are debts the company owes that are to be settled in the near term, in the next twelve months.

These include taxes due, staff wages due, bank overdrafts, vehicle or higher purchase finance due shortly.

It’s really important that for the most part a company’s current assets exceed its current liabilities.

If not, the company would be considered insolvent – not good.

Non-Current Liabilities

The liabilities that are expected to be repaid in more than twelve months.

These include long-term loans and long-term financing arrangements such as vehicle finance.

Equity

As mentioned above, equity is the remainder. It’s what’s left if the company were to sell all its assets and repay it’s debts.

Equity comprises of the share capital the company has raised and it’s cumulative historical profits and losses.

Equity is normally understated as the current market value of the company is not normally recorded on the balance sheet (or anywhere). So, if equity is looking a bit low, don’t be alarmed.

Some important balance sheet balances…

Shareholders current account – ensure that this is a liability to the company. That means the company will owe it’s shareholders money. So, this balance should be sitting under the Current Liability heading of the balance sheet. If it’s sitting under Current Assets, you need to be careful and speak with your accountant urgently, you don’t want this to be the case.

Income Tax Liability – keep an eye on this balance. You want this to be manageable as time goes on. If it’s growing year on year, be careful as the company may be falling short on paying it’s tax bills.