Business advisor and author of The Startup Coach, Carl Reader, explains what a balance sheet is. A balance sheet shows a snapshot of the value of the business, based on what it owns (assets) versus what it owes (liabilities). Very simply, this report gives you a “net worth” which would be the valuation of the business should you decide to close the business and sell all the assets for what they are worth, and repay all the loans and creditors at this point.
The balance sheet will be made up of several components, including:
- Fixed Assets – these are the assets that the business owns, and broadly speaking the assets which would be held for more than one year (otherwise known as “capital assets”). These can be split between “tangible assets”, which are assets that you can see and touch (for example motor vehicles, furniture, computers and machinery); and “intangible assets” such as licences, and goodwill.
- Current Assets – these are assets that are expected to be used within the day to day trading of the business. Items that would be included within the current assets section would be cash at bank, petty cash, debtors, and work in progress. There would also usually be an adjustment for “prepayments”, which is an accounting adjustment to ensure that the financial results reported are in line with what actually happened during the year, rather than based on cash flows (see below – Matching concept).
- Current Liabilities – these are moneys owed to other people and businesses, that are of a short term nature (less than one year), or repayable on demand. Such liabilities include bank overdrafts, credit card liabilities, trade creditors and accruals (again, see below – Matching concept).
- Long term Liabilities – these are liabilities which have a longer term of repayment, and hence are separated from the more immediate items. These are usually more structured, and might well be secured against an asset of the company.
Balance sheets are of particular interest to financial institutions as they show the financial health of the business, and allow the reader to determine whether the business has enough “liquid assets” (current assets less current liabilities) to continue trading.
A key difference that you need to bear in mind when comparing the balance sheet to the profit and loss account is that the balance sheet is simply a “snapshot” of the business at a single point in time, whereas the profit and loss account is a report on the performance of the business over a period of time.