Reporting Financial Condition: The Classified Balance Sheet
The assets, liabilities and owners’ equity of a business are reported in its balance sheet, which is prepared at the end of the profit and loss account period. The balance sheet is not a flow statement but a position statement which reports the financial condition of a company at a precise moment in time – unlike the income and cash flow statements which report inflows and outflows. The balance sheet presents a company’s assets, liabilities and owners’ equity that exist at the time the report is prepared.
Current (short-term) assets
Short-term, or current, assets are:
- Marketable securities that can be immediately converted into cash
- Operating assets that are converted into cash within one operating cycle
Operating cycle refers to the process of putting cash into stock, selling products on credit (which generates debtors) and then collecting the receivables in cash. In other words, the operating cycle is the ‘from cash – through stock and debtors – back to cash’ sequence. The term operating refers to those assets that are directly part of making sales and directly involved in the expenses of the company
Current (short-term) liabilities
Short-term, or current, liabilities are those non-interest-bearing liabilities that arise from the operating activities of the business, as well as interest-bearing overdrafts that have a maturity date one year or less from the balance sheet date. Current liabilities also include any other liabilities that must be paid within the upcoming financial period.
Costs and Other Balance Sheet Values
The balance sheet summarizes the financial condition for a business at a point in time. Business managers and investors should clearly understand the values reported in this primary financial statement. In our experience, understanding balance sheet values can be a source of confusion for both business managers and investors who tend to put all pound amounts on the same value basis. In their minds, a pound is a pound, whether it’s in the debtors, stock, fixed assets, or accounts payable. Assigning the same value to every account value tends to gloss over some important differences and can lead to serious misinterpretation of the balance sheet.
In the layout in Figure 6-4 we start with the fixed assets rather than liquid assets such as cash and work our way down. After the fixed asset sum has been determined to arrive at the residual unwritten down ‘value’ of those assets, in this case £5,525,000, we work our way down the current assets in the reverse order of their ability to be turned into cash. The total of the current assets comes to £8,555,000.
To run a business you need financial backing, otherwise known as capital. Capital is all incoming funds that are not derived from sales revenue (or from selling off assets). A business raises capital by borrowing money, getting owners to invest money in the business, and making profit that is retained in the business. Borrowed money is known as debt; invested money and retained profits are the two sources of owners’ equity.