Financial Reporting – Balance Sheet Part 2


Balance Sheets Part 2

Note: This post follows Balance Sheets 1 so read that if you haven’t already.

Some quick concepts / refreshers

  • The balance sheet is a statement of financial position at the time it is made
  • The cash flow statement measures movement of cash over time
  • An income statement measures the wealth generated over a period of time
  • If a machine has been leased for the whole of it’s useful life (like a van) then it can be an asset for the company. Basically if something is controlled by the business then it’s an asset. As a machine is leased for all it’s useful life, it is pretty much controlled by the business, making it an asset.
  • A trade payable is a liability. Trade payables are money owed to suppliers from when the suppliers have supplied things like goods or services to the company. As this is basically a debt, that makes it a liability.
  • Assets = Capital + Liabilities

Now we are going to go through another example to make some more balance sheets.

Balance Sheet Example

Remember Pauline from the last post? Well it turns out that she became really successful selling wrapping paper for some reason. Basically she’s built the company up a lot. Below is her balance sheet on 1st November.

Assets: £14,000 in the bank

Capital claims: £3,000 owner’s equity

Liability claims: £11,000 borrowed.

Claims total: £14,000

On 2nd November she buys £5,000 worth of inventories, on a 1 month credit.

On 3rd November the owner puts £6,000 into the business bank account.

On 4th November the company buys a second hand car for £3,000, which they pay for using a cheque

On 5th November they repay their lender £4,000, again with a cheque.

Lets make a balance sheet for the activities on each day.

2nd November

They bought £5,000 worth of inventories on credit. So now the balance sheet looks like this:

Assets

£14,000 in the bank

£5,000 worth of inventories (bought today)

Total: £19,000

Claims

£3,000 capital (owners equity)

£11,000 liability (borrowed)

£5,000 liability (trade payable, for the inventories)

Total: £19,000

Remember that the total assets = total claims!

3rd November

The owner put £6,000 into the business bank account.

Assets

£20,000 in the bank (up from £14,000 yesterday)

£5,000 worth of inventories

Total: £25,000

Claims

£9,000 capital (owners equity, up from £3,000 yesterday)

£11,000 liability (borrowed)

£5,000 liability (trade payable, for the inventories)

Total: £25,000

4th November

A second hand car was bought for £3,000, paid by cheque.

Assets

£17,000 in the bank (£3,000 down from yesterday to pay for the car)

£5,000 worth of inventories

£3,000 (How much the car is worth)

Total: £25,000

Claims

£9,000 capital (owners equity)

£11,000 liability (borrowed)

£5,000 liability (trade payable, for the inventories)

Total: £25,000

5th November

The lender was repaid £4,000 with a cheque

Assets

£13,000 in the bank (down £4,000 from yesterday for the repayment)

£5,000 worth of inventories

£3,000 car

Total: £21,000

Claims

£9,000 capital (owners equity)

£7,000 liability (borrowed, down from £11,000 as £4,000 was just paid off)

£5,000 liability (trade payable, for the inventories)

Total: £21,000

Note

It’s not really good practice to draw up a balance sheet at the end of every day so they are normally done at the end of a suitable period, like monthly, quarterly, even annually.

7th October

Imagine that the business sells off all their inventories for £7,000 in cash. The balance sheet would change like this:

  • The inventories would be removed from the balance sheet
  • The cash in the bank would increase by £7,000
  • So the total assets would go up by £2,000 (as removing inventories will take off £5,000 worth of assets)
  • The increase in profit would be a benefit for the owners so the capital would increase by £2,000 aswell (as the £9,000 put in is now worth £2,000 more)

Assets

£3,000 car

£0 inventories

£20,000 in the bank

Total: £23,000

Claims

Capital (owners equity): £11,000

Liability (trade payable): £5,000

Borrowings: £7,000

Total: £23,000

Alternative 7th October

Imagine that the inventory was only able to be sold for £3,0000. The balance sheet would therefore look like this:

Assets

£3,000 car

£0 inventories

£17,000 in the bank

Total: £20,000

Claims

Capital (owner’s equity): £8,000 (down from £9,000 as the loss decreases the capital)

Liability (trade payable): £5,000

Liability (borrowings): £7,000

Total: £20,000

Balance Sheet Equation Redux

We can redefine the balance sheet equation:

Assets = Capital + Profit + Liabilities

or

Assets = Capital – Loss + Liabilities

Asset Types

  • Current assets
  • Non current assets

Current Assets

  • Held in the short term
  • Held for sale/consumption in the normal course of business OR
  • Expected to be sold in the next year OR
  • Help primarily for trading OR
  • Cash / near cash

Examples

  • Stock
  • Trade receivables (to come in)
  • Cash

Current Asset Cycle

Current assets follow a cycle. They begin as a receivable, which is then converted to cash, which is then spent on inventory, which is then sold for more receivables etc (see below diagram).

Screen shot 2009-11-01 at 15.51.31

Non-current Assets

  • Things held for the long term

Examples:

  • Land
  • Buildings
  • Equipment
  • Vehicles
  • Computers

Claim Types

Claims can be divided into current and non current liabilities, just like with assets

Current Liabilities

  • Things payable in the short term
  • Held primarily for trading OR
  • Expected to be paid off within the normal course of business OR
  • Within a year

Examples

  • Overdraft at the bank
  • Trade payables

Non-current Liabilities

Things due to be paid after more than a year

Examples include long term loans and debentures.

Some Examples

  • A delivery van and an office computer are both non current assets
  • A bank loan to be repaid is a non current liability
  • Money owed by customers, cash in the office safe, and electronic parts to be used in the production process are all current assets
  • A bank overdraft and an unpaid electric bill are current liabilities
  • Money the owner puts in is capital

That’s all folks.

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About Shaun
I'm super cool and I do computer science (unrelated to the coolness)

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