What is a balance sheet or statement of financial position?

A balance sheet shows the assets and liabilities of the business. It summarises the financial health of a company, showing how it is funded and what it has done with that funding; this is why a balance sheet is now recorded as a ‘Statement of Financial Position’ in accounting terms (see how this differs from a cash flow forecast, or a statement of profit and loss in our respective guides to those).

It shows how a company is funded and what the company has done with that funding.

What is on the balance sheet?

The balance sheet is presented in two sections:

• Assets such as properties, furniture and fittings, equipment, stock for sale, cash and money owed to you.
• Liabilities such as your bank overdraft, loans and other money you owe.

Balance sheets are usually laid out in this format:

The two figures “total assets” and “capital at end of year” are the same – they must be, as the whole point of a balance sheet is to balance the two sides of your accounts. Assets are paid for by the capital introduced into the business to enable it to run.

Proprietor’s interest (also known as equity) simply means the amount of money you have tied up in the business.

Accounting terms explained

These are some common terms you may find it useful to understand:

Fixed assets includes items you own and will keep for a long period for use in the business, rather than sell for a profit. This covers buildings, fixtures and fittings, vehicles, equipment and plant. You could think of these as the items that depreciate (although this might not apply to buildings in a rising property market).

Other assets, sometimes called intangible assets, covers things such as goodwill, and the value of any licences, copyrights, trademarks or patents you might own.

Current assets includes money you can use quickly, including cash in your till and credit at your bank, money owed to you by customers, your stock and any pre-paid expenses which you could, theoretically, get back, such as the rent on your premises.

(Money owed by your customers here means money you are confident of collecting. If you are uncertain about payment, you need to have another section in your balance sheet called “provision for bad debts”. So if customers owe you a total of £10,000, and you think you may not be able to collect £2000 of it, you show £8000 under “accounts receivable” and £2000 under “bad debt provision”.)

Current liabilities includes amounts you owe and will have to repay within one year, such as your suppliers’ invoices, a short-term loan, your overdraft (which is in this section because it is usually repayable on demand), VAT, or other taxes due.

Long-term liabilities includes long-term loans such as mortgages or lease payments on vehicles. Companies are funded through a mixture of debt and equity. The debt of the company can be found in the Long Term (or Non Current) Liabilities; and the equity in the Shareholders’ Funds (sometimes called Capital & Reserves). The debt plus the equity represents the total capital employed in the business.

Understanding depreciation

Depreciation is a figure given each year to the loss in value of items such as equipment and vehicles. Say you buy a new piece of machinery for £10,000, and expect it to last ten years before you replace it. At the end of those ten years it will be worth nothing, so it will have reduced in value each year by £1000 – which is called its depreciation.

The depreciation of value of these items is written into your accounts as a loss, reducing your taxable profit.

There are some conventions that govern the lifetime of certain types of item. These are used because the HM Revenue & Customs accepts them as reasonable.

Note that sometimes rules on depreciation change, even temporarily. For example, in the recent Finance Act, the Chancellor updated the scheme for 100 per cent first year capital allowances for investments in designated energy-saving equipment. This means you can immediately write off against taxable profits your capital spending on designated energy-saving plant and machinery, reducing your tax bill.