Tax & admin · 31 January 2018

What is a balance sheet and how to read one

Reading another firm’s balance sheet could help you understand this key financial document
As a small business owner, youll probably own lots of assets, owe people money and have shareholders. Here, Business Advice expert Rob Drury explains what is a balance sheet, and how all of these get’summarised within it.

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? (assetsthat can easily be turned into cash), and long-term assets? (assets that would take time to be able to turn into cash).

What is a balance sheet?
Current assets can include inventory, which is stock you can sell.
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
Long-term assets can include:

    • 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 youd 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
      • Tax
      • Salaries for your staff
      • Dividends
Long-term liabilities can include:

      • Pension fund contributions
      • Deferred tax
      • Debts which arent 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:

      • Investmentsby shareholders through common and preferred’shares in the business (equity)
      • Earnings that have been kept back for future investment (retained earnings)
Shareholder equity can be calculated in a number of ways. For example, assets minus liabilities equals shareholder equity, or share capital plus retained earnings minus treasury shares.
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How to read a balance sheet

A 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 aliability, and a new share issue adjusts the’shareholder equity, for example.

What is a balance sheet?
A balance sheet is a snapshot in time.

 
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ABOUT THE EXPERT

Former footballer and cinema manager Robert Drury has been a digital professional since 2000, specialising in project management, client services, and product management. He supported global brands such as Kraft Foods, Peugeot Citroen, and Lloyds Banking Group with their online presence before moving into startups. He was a founding team member at Ormsby Street, a small business financial information tool, before moving to Qudini to oversee the development of that firm's customer experience software product.

Business Law & Compliance