What is a balance sheet?Every business owner operates with three core financial documents: the balance sheet, the profit and loss statement and the cash flow statement. It?s the balance sheet that summarises the company?s assets, liabilities and the shareholder?s equity at a particular point in time. The so-called ?balance? being that the assets must equal the sum of the liabilities and the equity. For example, if a business owner has borrowed ?10,000 from the bank (a liability) and has had ?10,000 invested by its shareholders (shareholder equity), then the business has ?20,000 of cash at its disposal (an asset).
What is classed as an asset?There are many things that would be classed as assets in a business sense, and a common way of categorising them is to split them between??current assets? (assets?that can easily be turned into cash), and??long-term assets? (assets that would take time to be able to turn into cash). Current assets can include:
- Cash, and other things that are similar to cash, such as certificates of deposits or treasury shares
- Accounts receivables, or money owed to you which you can chase to get paid
- Inventory, which is stock that you can sell
- Land, buildings, equipment, machinery and other big capital expenditure items
- Intangible things, like intellectual property
- Investments which have a time limit on when they can be cashed in
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What is classed as a liability?As you?d expect, liabilities are things that the business is liable for and, like assets, they can be classified as either current or long-term. Current liabilities can include:
- Bank overdrafts
- Interest payable
- Operational costs like rent or utilities
- Salaries for your staff
- Pension fund contributions
- Deferred tax
- Debts which aren?t due within a shorter time period
What is shareholder equity?As with assets and liabilities, shareholder equity is made up of a few elements. These can include:
- Investments?by shareholders through common and preferred?shares in the business (equity)
- Earnings that have been kept back for future investment (retained earnings)
What is bad debt and how can I avoid it? If you?re new to business ? or are thinking about starting up on your own ? one hazard you may have heard of is exposure to ?bad debts? __________________________________________________________________________________
How to read a balance sheetA balance sheet is only a snapshot in time, and constantly changes as the elements that make up the balance sheet are in regular movement. A new sale adds an asset, a new member of staff adds a?liability, and a new share issue adjusts the?shareholder equity, for example. Because of this snapshot nature, it?s important to compare balance sheets with other balance sheets over time. In terms of reading the balance sheet, there are a number of ratios that can be used to give business owners greater insight.? Debt to equity ratio (total liabilities divided by total shareholder funds) A business that has a high debt to equity ratio is described as??highly geared? or??highly leveraged?, which makes them less attractive to lenders. Payments for the debts can be?requested within a short time frame, whereas shareholder equity is a longer-term form of finance. The ratio can never be perfect, as it can depend on industry-wide factors. If you are running a comparison, then do so against comparable businesses in the same industry. The kind of questions owners should ask are:
- Is the business?s sales revenue predictable and generating cash?
- Are the debts likely to be require payment quickly?
- Is the business vulnerable if the economy takes a downturn???
Understanding balance sheetsIf you?re wanting to find more about what a balance sheet is, a good place to start is to head to Companies House. Find the accounts of comparable businesses to your own and look for their balance sheets. You can use the balance sheets of other businesses to review and assess their ratios, and help you understand the ins and outs of this key financial document. Read more: A handy guide for paying off your tax bill to HMRC
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