Financial Reporting - Balance Sheets Part 1

Balance Sheets Part 1

The major types of financial statement

3 types:

• Cash flow statement


• Income statement


• Balance sheet

Explaining the 3 types with an example

Introduction

Pauline wants to sell 'generic winter celebration paper' on her local high street. She has £40 in cash to start the business. On Monday she buys £40 worth of paper and sells 75% of it for £45. What cash movements took place on Monday? Let's make a cash flow statement to work out the answer to this:

Cash Flow Statement

Opening cash balance (How much cash was introduced): £40

Add on the cash from sales: £45

Total: £85

Now take away the cash used to buy paper: -£40

Leaving us with a closing cash balance of £45

Now let's work out how much profit (or loss) the business generated. This is called an income statement:

Income Statement

Sales revenue (How much money Pauline took): £45

Take away the cost of goods that were sold. Pauline sold 75% of the £40 stock, so here the answer is: £30

Leaving us with a profit of £15

Finally we are going to work out the accumulated wealth on Monday evening with a balance sheet:

Balance Sheet

Closing balance (worked out from the cash flow statement): £45

Inventories of goods for resale (Pauline has one quarter of the £40 stock left): £10

Total business wealth: £55

Intro to Tuesday

Pauline decides to carry on the business into Tuesday. She buys more paper for £20, and sells all the old stock AND the new stock for £48. Let's make the 3 financial statements again to reflect Tuesday's business:

Cash Flow Statement

Opening cash balance (leftover from yesterday): £45

Add on the cash from sales (which was £48): £93

Take away the cash used to buy more paper (which was £20): £73

Income Statement

Sales revenue (How much was made from sales): £48

Take away the cost of goods sold (She sold the £20 of new paper, PLUS the £10 worth of paper leftover from yesterday): £30

So the profit for Tuesday is £48 - £30 = £18

Balance Sheet

Closing balance (from the cash flow statement): £73

Inventories of goods for resale (Pauline has sold everything so there is nothing left): £0

Total business wealth: £73

Note about the statements:

One key thing to take away from this is that you need to make a cash flow statement and an income statement in order to make a balance sheet.

Assets

There are 4 main things that define an asset, that is to say what makes something an asset and not just a 'thing':

• A probable future benefit exists


• The business has the exclusive right to control the benefit


• The benefit must arise from a past transaction or event


• You must be able to measure the asset in terms of money

Some examples of assets

Notice how all these things can meet the definitions I just talked about!

• Buildings


• Vehicles


• Computer Equipment


• Inventories (Stock)


• Cash


• Trade receivables (things like debtors or money owed. If someone owes you money then that's an asset to you)

Things that are NOT assets

• A leased company car (It's only leased so the company can't sell it for profit)


• The expertise of the R&D team (You can't measure it in terms of money)

Claims against businesses

There are generally two types:

• Capital


• Liabilities

Capital

• These are resources that are put into the business by the owner, for example shares or equity


• Profits earned in the business also fall under this term

Liabilities

• These are the claims of others (either organisations or just individuals) against the business that come from past events or transactions


• Examples of these include creditors and loans

Another Example!

Mark and Company start a business by depositing £20,000 into a bank account on 1st March. This amount was raised partly from the owner (£6000) and the rest came from borrowing (£14,000).

Balance Sheet at 1st March

Assets (this is the cash in the bank): £20,000

Capital claims: £6,000 (from the owner)

Liability: £14,000 (borrowed from the bank)

The balance sheet equation (important!)

Assets = Capital + Liabilities

That's all for balance sheets, well done for getting this far!

There is an online test with 5 questions on BlackBoard that goes with these notes, it's worth trying