Balance Sheet Explained
Most business owners can get their head around the basics of a profit and loss account. The balance sheet on the other hand isn’t so obvious for the average non-finance savvy small business owner.
The profit and loss shows what has happened over a certain period of time, whilst the balance sheet is a snapshot of the financial standing of a business at a particular point in time.
- Company name and current year/period end.
- Current period’s figures (NB may be anywhere from 1 day to 18 months).
- Previous period’s figures (comparative).
- Fixed assets expected useful economic life >2 years. Bought to help the business operate, not resale. Eg motor vehicles and computers. Can include intangible fixed assets, which are things that you can’t see or touch. Examples include the value of patents/trademarks, or goodwill.
- Current assets more readily turned into cash. Stock is the hardest to convert (least liquid) so appears first. Next comes debtors (people who owe you money) then cash itself (the most liquid asset). More detail further down page.
- Bank accounts NB can be assets (positive bank balance) or liabilities (bank overdraft/loan). Indeed one company might have both at the same time.
- Current liabilities expected cash outflows (debts) in <12 months. More detail further down page.
- Net current assets how easily the business can pay immediate debts. A high figure means a safe business. A negative figure means short term debts payable are larger than the value of assets readily available to turn into cash.
- Long term liabilities expected cash outflows after >12 months, typically bank loans/hire purchase agreements.
- Net assets total assets less total liabilities. A negative figure indicates business is insolvent (cannot repay all its debts).
- Capital and reserves how the business is funded. Normally initial cash injection (share capital) plus retained profits to date. More complex companies may have several types of share capital, share premium (shares sold for more than face value), revaluation reserves (property valued above purchase price) or capital redemption reserve (rare).
The main classes of current assets are:
- Stock – can be split down further into raw materials, work in progress and finished goods. Keeping the right level of stock can be tricky. Too much and cash is tied up for ages, plus you risk stock becoming obsolete. Too little and you risk losing sales due to long lead times to get goods to the customer.
- Trade Debtors – customers you have sold to on credit who have not yet paid. Keep tabs on these to ensure customers pay when they should. Chase up any slow payers quickly but politely.
- Prepayments – goods/services that you have been invoiced for but not yet got the benefit of. Eg insurance paid annually up front.
- Accrued income – often combined with prepayments. Work you have (partially) performed but not yet invoiced to the customer, perhaps as the job is not yet complete.
- Other Debtors – money owed by a non-customer. This could be a repayment of tax due from HMRC, or perhaps the business has issued a loan to another business.
- Bank account – includes both current and deposit accounts. If you have a positive deposit account balance, but an overdraft on your current account, they should not be combined. The deposit account should appear here, and the overdraft in current liabilities.
- Cash in hand – petty cash held. This balance should be kept low to minimise the risk of theft.
Having high current assets is typically considered “safe”, as you should be able to get your hands on plenty of cash quickly if you need to. Note that care must be taken to ensure stock is not obsolete (ie it is really worth the value shown) and that debtors are recoverable (ie they will pay you).
Whilst typically safe, high current assets don’t necessarily help the business become more profitable. Having lots of cash in the bank, or a warehouse full of stock is not always good use of money.
The main classes of current liabilities are:
- Trade Creditors – Suppliers you have bought from but not yet paid. Delaying payment to suppliers improves cash flow, but delaying too much may make them reluctant to deal with you again.
- Accruals – goods/services used by the business, but not yet invoiced. These can include an estimate of the cost of phone calls recently made, or professional advice received but not yet billed.
- Defered income – often combined with accruals. Work you have invoiced in advance of performance. This can include payments on account and deposits.
- Bank loan/overdraft – overdrawn balances on current accounts and loans. For long term loans, only the amount repayable within 12 months is shown here, the remainder in long term liabilities.
- Taxes – often current liabilities will include VAT, corporation tax and/or PAYE/National Insurance.
- Other Creditors – money owed to someone other than the above. In small businesses often this will include things such as director loans to help improve the cash flow.
High current liabilities can be considered risky. It means a lot of cash is expected to flow out of the business in the near future. If there aren’t sufficient current assets providing that cash, the business could be in trouble.
Having said that, the majority of businesses are in debt. If your business makes a higher profit margin than the bank charges in interest, net borrowing is not necessarily a bad thing.
If you want to keep track of your own books, Maslins recommend FreeAgent online invoicing & bookkeeping software. It comes included with our pay monthly contractor accountancy package.
If you have any questions, get in touch!