Guide to explaining the Financial Balance Sheet

Many business owners can pick-up the basics of a profit and loss account without too much trouble. For non-financial users, the balance sheet continues to be a source of continued exasperation.

The profit and loss is a measure of how well a business has performed over a period of time (say 1 year).

A balance sheet on the other hand is a financial snapshot at a particular point in time.

Let’s examine a fictional balance sheet and discuss the various headings and definitions:

1. The company name and current year end will be found at the top of the balance sheet.
2. Shows the current period figures. This can be anything from 1 day to 18 months.
3. The previous periods figures are shown for ease of comparison
4. Fixed assets are usually pieces of property, plant or equipment that are brought to help the business make money. They have an expected life > 2 years. Can include “Intangible Fixed Assets” like intellectual property rights or goodwill.
5. Current assets are assets that remain on the balance sheet for < 1 year. They are ordered by how easily they are able to be converted to cash (or its equivalent)
6. The balance of the bank account can appear in Current Assets or Current Liabilities if the account is overdrawn and using an overdraft facility.
7. Current Liabilities detail any financial obligation (or debt) that will become due over the next 12 months.
8. Net Current Assets illustrates the businesses ability to meet its current debts. A high figure shows a greater margin of safety whilst a negative figure will probably mean the business is in danger of failing.
9. Long Term Liabilities are expected cash out-flows that will become due after 12 months. Examples usually include loans from banks or people.
10. Net Assets is arrived at by subtracting total liabilities from total assets. For an insolvent business the figure will be negative there won’t be enough assets to meet the liabilities.
11. Capital and Reserves illustrate how the business is funded. This usually shows the initial source of funding (capital) plus any retained profits carried over. Larger companies will have several different types of shared capital (preferred, ordinary, etc)