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Financial position - the balance sheet

We all know intuitively what an asset is - money, gold, a building; and also what a liability is: a debt, a loan that has to be repaid, a tax bill. Here are the accounting standard definitions:

The elements directly related to the measurement of financial position are assets, liabilities and equity. These are defined as follows:

(a) An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.

(b) A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

(c) Equity is the residual interest in the assets of the entity after deducting all its liabilities.

A simple balance sheet and a layout used for management purposes

The layout below gives clarity to the fact that there are the two classes of financial strategy available in the business world, strategies that deliver by: (1) making profitable and efficient use of assets and (2) structuring the business's financing or funding. This simple example (Table 3.8) is formatted to show the two sides of a balance sheet from a management and a strategic perspective.

Balance sheet as at date

Net assets X

Tangible, physical, measurable assets less short-term liabilities

Finance X

Equity or share capital plus

profits left in the business by the investors

plus loans from lenders

TABLE 3.8 Example

BALANCE SHEET - as at 31 March 20XX

Fixed assets/non-current assets

7370

Current assets

Inventories/stock

510

Receivables/debtors

435

Bank and cash

25

970

Current liabilities

Overdrafts

(105)

Payables/creditors

(625)

Taxation

(35)

(765)

Net current assets = Working capital

205 1

Net book amount/net worth/capital employed

7,575

Non-current liabilities/long-term debt or loans

2,355

Equity/Shareholders' funds

Common stock/share capital

2,000

Retained or accumulated earnings or profit or loss

3,220

5,220

Capital invested/capital employed

7,575

Two basic definitions:

- Net assets employed: tangible, intangible and financial assets (buildings, equipment, inventories, receivables, cash) less liabilities principally relating to operating activities and due to be settled within a short period (a year or much less). This is the net worth of the business or capital employed in the business as visibly seen, recorded, measured and managed by the executives and employees.

- Finance: this is what finances the business, ie the capital employed in the business, but from the perspective of the investor. It is the owners' and lenders' investment in the business. This side should be exactly equal in amount to the net assets employed side, X = X.

In accounting terms, a balance sheet is a statement of assets and liabilities of a business at a point in time. Assets owe value to the business and liabilities are value owed to others - either third parties (suppliers, tax authorities) or suppliers of finance (stock- or shareholders and long-term lenders).

A balance sheet thus shows assets owned and holding value less liabilities to third parties - the net worth or net book amount in one section. This is then balanced by an equal amount which represents the amounts owed to the suppliers of the finance - the stock- or shareholders and long-term lenders.

Assets employed Non-current or fixed assets + Current assets - Current liabilities

= Net worth, net book amount or capital employed Financed by

Stock- or shareholders' funds or equity + Long-term (non-current) finance = Total funding, net worth or capital employed

These and further common UK and US terms are explained in the glossary.

 
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