Up to speed on why balance sheets are so important? Now you’re ready to understand them inside-out.
This financial statement acts like a snapshot of your business’s assets, liabilities and equity at a specific date. That information can be used in conjunction with your profit and loss account to calculate income tax, meet legal requirements and spot opportunities to optimise.
Here are the statement’s elements:
We class current assets as those likely to be converted into cash within 12 months of the balance sheet date. It means the value shown in the balance sheet is likely to match the eventual cash the business will receive.
|Type of current asset||How it converts to cash|
|Bank accounts||Not applicable, as it’s already cash|
|Any cash in floats or tills||Not applicable, as it’s already cash|
|Accounts receivable (people who owe you money)||Your customers will pay you cash|
|Stock on hand (goods you’ve purchased to sell, but haven’t sold yet)||You’ll sell these goods to customers, who will pay you cash|
|GST or tax refunds owing by Inland Revenue||These will be paid into your bank account (or used to pay other amounts due to the IRD)|
These assets are used to carry out business activities or generate interest or dividends for the company. They aren’t expected to be converted into cash within 12 months (though, they can be).
While their value is recorded at their original purchase price, it’s important to keep in mind that that isn’t necessarily what they’d be worth if they were to be sold. For example, vehicles and machinery decrease in value over time, and land values can increase.
|Type of non-current asset||How it is used by the business|
|Property, plant, and equipment (land, building, vehicles, machinery, furniture, etc)||The business needs these non-current assets to generate income|
|Investments in shares||This could be shares in the stock market, and/or shares held in a related company|
|Term investments||As these can usually not be accessed without losing interest, they are classified as non-current|
|Loans||These can include loans made to shareholders, the business owners, other companies, and family members|
Current liabilities are expected to be paid within 12 months of the balance sheet date.
|Type of current liability||Situation|
|Bank overdraft||You owe money to the bank|
|Credit cards||You owe money to the credit card company|
|Accounts payable (suppliers you owe money to you)||You need to pay suppliers for goods purchased or services used|
|Wages payable||Your employees have performed work, but you haven’t yet paid them|
|GST, PAYE, tax payments due to Inland Revenue||You owe money to Inland Revenue|
Non-current liabilities don’t usually require payment within the next 12 months. The most common type of non-current liability is a long-term loan.
The equity section is what you might call the balancing figure and it represents the ultimate value of the business to its owners.
Equity = assets – liabilities
Within equity, retained earnings is the most interesting figure. It represents the profits from previous years that have been kept in the business, rather than paid out to shareholders.
Equity for sole traders
Equity (called the Capital Account in your financial statements) will comprise your profits to date, the money you’ve deposited in the business bank account, and drawings.
It’s possible for equity to become negative – when liabilities exceed assets. Such situations are an indicator of insolvency – the business’s ability to continue operating. If this applies to you now or appears likely in future, we urge you to seek professional advice. There can also be serious legal consequences for continuing to trade while insolvent.
We treat a balance sheet like a snapshot of asset’s liabilities and equity on a specific date. Let’s see what it can look like at 31 March 2021:
Bank account – $3,000
House – $785,000
Total assets – $785,000
Credit card balance – $1,000
Mortgage – $523,000
Total liabilities – $524,000
Net worth – $264,000 ($785,000 less $524,000)
Changes during the year
- On 1 April 2021, you borrow $4,500 to purchase a vehicle
- The asset and the loan will not be included in the balance sheet at 31 March – they didn’t exist at that date (for you). On 1 April 2021 your assets and liabilities would both increase by $4,500.
- On 31 October 2021, you have an unconditional agreement to sell the house for $825,000; settlement will take place on 30 November 2021
- At 31 October 2021, your equity has increased by $40,000 ($825k less $785k), and is now $304k. The $40k increase doesn’t mean your equity at 31 March was incorrect – it’s just that we’re recording the value of the asset at a different date.
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