Balance sheet

Balance Sheet

A balance sheet is a statement which shows the financial position of a business at a particular date. It shows the assets on one side and liabilities on the other. Assets are divided into two categories: fixed assets and current assets.

• Fixed assets are possessions of the business that assist in its operations and benefit the business for more than one accounting period.
• Current assets are assets of the business used in generating income during the accounting period.

Liabilities are also grouped into two types: long-term liabilities, which are payable in more than one accounting period, and current liabilities, which are payable within the accounting period. The following is the format of a balance sheet showing the common items that appear on it.

XYZ TRADERS

BALANCE SHEET as at 31st December 2004

LONG TERM LIABILITIES

Loan	xxxx

FIXED ASSETS

Motor vehicle	xxx
Less: Depreciation	xx
Net value of Motor vehicle	xxx
Furniture	xxx
Less: Depreciation	xx
Net value of Furniture	xxx

CURRENT LIABILITIES

Creditors	xxx
Owing expenses	xxx

CURRENT ASSETS

Stock	xxx
Debtors	xxx
Prepaid expenses	xxx
Bank	xxx
Cash	xxxx

OWNER'S EQUITY

Capital	xxx
Add: Net profit	xx
Less: Drawings	xxx
Owner's Equity	xxx

NB: Net loss is subtracted from the capital. Stock appearing on the balance sheet is the stock at the date of the balance sheet.

Posting Entries in Balance Sheets

Example 1

Considering FMHN Trading Co. from above example, the balance sheet will be as

FMHN TRADING CO

BALANCE SHEET as at 31st December 2004

LONG TERM LIABILITIES

Capital	41,590
Add: Net profit	9,091
Total	50,681
Less: Drawings	9,500
Net Capital	41,181

FIXED ASSETS

Machines	4,550
Less: Depreciation	455
Net Machines	4,095
Motor vehicle	5,520
Less: Depreciation	1,104
Net Motor vehicle	4,416

CURRENT LIABILITIES

Creditors	16,275
Office expenses owing	110
Total Current Liabilities	16,385

CURRENT ASSETS

Stock	27,340
Debtors	20,960
Cash	755
Total Current Assets	49,055

Balance Sheet Equation: Assets = Capital + Liabilities

Interpreting Information from the Balance Sheet

From the balance sheet, useful information concerning the business can be extracted. The interpretation then depends on the use of the information. The following are some of the useful information provided by the balance sheet.

1. Capital: The capital available at the date of the balance sheet is shown after adjusting the previous capital.

2. Working Capital: Working capital or circulating capital is given by:

$\text{Working Capital} = \text{Current Assets} - \text{Current Liabilities}$

3. Liquidity Ratio: This ratio measures the ability of the business to repay current liabilities out of the current assets. The ratio can be shown in two ways:

   i. $\text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}$

   ii. $\text{Quick Ratio} = \frac{\text{Current Assets} - \text{Stock}}{\text{Current Liabilities}}$

The quick ratio measures the ability of the business to pay current liabilities out of current assets excluding stock which is considered less liquid.

From the balance sheet of FMHN Trading Co. we can find the following.

1. Capital at 31st December 2004: 41,181/-

2. Working Capital:

   $\text{Current Assets} - \text{Current Liabilities} = 49{,}055 - 16{,}385 = \mathbf{32{,}670}$

3. Liquidity Ratios:

   1. Current Ratio:

      $\frac{\text{Current Assets}}{\text{Current Liabilities}} = \frac{49{,}055}{16{,}385} \approx \mathbf{2.9 \approx 3}$

   2. Quick Ratio:

      $\frac{\text{Current Assets} - \text{Stock}}{\text{Current Liabilities}} = \frac{49{,}055 - 27{,}340}{16{,}385} = \frac{21{,}715}{16{,}385} \approx \mathbf{1.3}$

Note: The liquidity ratio is considered favorable if it is greater than or equal to 1.