- Balance sheets - this lists the value of a company's assets and liabilities
- Assets - items of value owned by a business
- Liabilities - debts owed by a business
- Liquidity - how easy it is for a business to pay its short term debts (turn its assets into cash if and when required)
- Fixed assets - these are items owned by the business with a lifespan of more than one year and are assets that are harder to liquidate into cash e.g. buildings and machinery
- Current assets - these are assets owned by the business that are either in a cash form or are likely to be turned into cash within the year e.g. stock, cash in the bank, cash in hand.
- Current liabilities - short term debts of the business which have to be repaid within the year e.g. money owed to suppliers for goods received
- Net current assets - If the business has short term debts greater than current assets it may have difficulty paying these debts and continuing to trade
- Net assets - the value of assets after all liabilities have been subtracted
- Capital and reserves - the cash available to run the business and will include retained profits and the values of shares issued and purchased by shareholders
In the news In autumn 2008 customers of Northern Rock started panicking and queuing up to withdraw all their savings. The company could not find cash quick enough and eventually to stop the panic the government launched a rescue attempt by NATIONALISING the bank to guarantee the savers deposits. Much of the lack of confidence was due to the items not visible on the balance sheet. The bank had lent money to some who where a high risk of defaulting. These high risk debts were liabilities and should have appeared on the balance sheet but were hidden. If they had have been visible they would have shown how much risk was being carried by the bank. The riskiest of these debts were so well hidden on the balance sheet no one in the public could see them as they were kept 'off balance sheet' These debts were held under another company name in offshore accounts which was legal to do at the time.
Web based activity All public limited companies have to produce a balance sheet and make it available to the public. Often these are available online. Go to the corporate website of a company in which you are interested and look at its balance sheet. What judgments can you make about the business from the balance sheet. What else do you need to know to support your judgement?
The balance sheet shows what the business has in the way of possessions and how these have been financed. It therefore shows the business how much it owns as against how much it owes - simples !
Assets The balance sheet may be divided into THREE parts:
- LIABILITIES, and how
- CAPITAL has been raised.
Liabilities The second part of the balance sheet shows liabilities - these are all the things that a business owes. These are either CURRENT debts that need to be paid back within a year such as a bank overdraft or creditors or LONG TERM - debts that a business has more than a year to repay, such as long term loans and mortgages. These are separated out in the account.
Working capital is calculated as current assets minus current liabilities. This figure is important as it shows the ability of the business to repay its short term debts. If there is a positive working capital balance then it is possible for the business to meet its day to day needs. Suppliers, banks, and other creditors will be confident that they will not only be paid but they will be paid on time. If working capital is negative the business will struggle to pay its bills
Net assets employed shows fixed assets (in this case £200,000) plus working capital (£40,000) . From this figure the business then takes away its long term liabilities to show its NET ASSETS. This is what the business is worth at this moment in time.
These assets have been financed in various ways, including loans, retained profit, and share issues. This is shown on the final part of the balance sheet - the CAPITAL ACCOUNT
Using the balance sheet The balance sheet has limited use as it can only be used to represent a situation at a particular moment in time. It is therefore looking at FLOWS of FINANCE and changes in such flows. To show trends you would need to compare one balance sheet at one point in time with another taken earlier or later. It is therefore often referred to as a SNAPSHOT. It is however very important to:
- mangers and
Exam questions based around understanding assets and liabilities on a balance sheet
- What is meant by an 'asset'?
- Explain the difference between fixed assets and current assets.
- A strong brand name would be considered to be what sort of asset?
- Define 'creditor'
- What is meant by 'liability'?
- Explain the difference between current liabilities and long term liabilities.
- Define 'debtor'
- What is meant by 'capital'?
- Explain what is meant by 'working capital'
- Outline what is shown on the capital account.
Nine mark question