A balance sheet is a statement of a business’s assets, liability and net worth. It is normally laid out according to the Companies Act formats although some bookkeeping and accounting systems produce documents in alterative layouts.
The purpose of a balance sheet is to show the type of assets a business has and then to describe how these have been financed.
Assets shown on a balance sheet can be sub-divided in to intangible and tangible groupings. The former category contains items such as goodwill, trademarks and research and development expenditure.
The valuation of these items is subjective as their true worth can only be known following a successful sale of either the asset separately or the business as a whole.
Prudence and caution in assigning amounts to intangible assets might result in the balance sheet displaying them with conservative valuations, far removed from what they are actually worth.
Tangible assets typically attract far more objective valuations as they exist usually as a result of a measurable transfer or exchange on which a monetary value can be assigned.
Items within the category include furniture, machinery, computers and other assets which are typically used in a business for a number of years.
Depreciation and Amortisation
Both intangible and tangible assets are usually subject to depreciation or amortisation which represents the usage of those items during the year.
Different classes of assets may have varying periods over which they can be used, for example, a building will be capable of serving the business for a longer time than a desktop computer would.
The depreciation of the computer would therefore be faster than the amortisation of the building. The reduction in the asset’s value shown of the balance sheet would therefore reflect the expected useful life over and benefit which would typically accrue to the business.
This class of assets are shown below fixed items on the balance sheets and represent the working capital of the business. Cash and other current assets are used to pay suppliers and other short term creditors so that the operations remain solvent.
Where current assets are not available for this purpose, the business will be forced to liquidate some from the fixed category which may in turn significantly curtain its ability to conduct its operations in the longer term.
For the purposes of this article liabilities will be used to describe all items involved in financing the business including shareholders funds.
In order for the business to have commenced its operations it would have had to have received an injection of funds from some source. This might have been from the entrepreneur’s own savings or alternatively from an external body such as a bank or suppliers in the form of credit.
At any one time, it is likely that the business owes money to creditors for purchases it has made and perhaps to other financiers of its operations. These amounts are depicted either current or long term liabilities.
Generally, those amounts form any source which are repayable within one year will be shown as current and those which are due after this period will be described as long term.
Some money might be owed to the shareholders, partners or sole trader who provided the business with its initial financing and expansion capital.
The distinction between owner liabilities and those which are owed to third parties in reality show the amounts which the business has some discretion over. It is unlikely that the owners would demand repayment of the sums of owed to them to the detriment of the operations.
Other third party creditors however would more likely be driven by self interest and would not have the long term future of the business at the forefront of the decision of whether to claim payments for amounts owed to them.