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).
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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