THE FINANCIAL STATEMENTS
KEY FINANCIAL INDICATORS
ACCOUNTING ISSUES
WHAT-IF ... SENSITIVITY MODELS
TIMING MATTERS
JUSTIFYING INVESTMENT
SCORECARDS AND VALUE MANAGEMENT

ACTIVITY: Statement of Financial Position Quiz

Research has shown that active recall, pushing yourself to recall new information rather than simply going over it again, has a big positive impact on learning and long-term memory. Also by trying to answer questions, you gain new insights and expose gaps in your knowledge.

So here is a short active recall activity. Click on the  heading to check your answer.

Whilst the income statement measures a company’s performance over time, the balance sheet or statement of financial position is a snapshot of a company’s financial position at a specific point in time. There are three broad categories on the balance sheet:

  • assets (normally divided into fixed and current)
  • liabilities (divided into long-term and current)
  • owners’ equity

The balance sheet is a digest of all the accounts. It represents a summary of every transaction that the business has ever undertaken, from trading through to taking loans and purchasing equipment. This amazing feat is accomplished through the magic of double-entry book-keeping.

They are fixed assets.

A tangible fixed asset is an item that a firm owns and uses in the production of its income and which is not expected to be consumed or converted into cash any sooner than at least one year’s time. Buildings, real estate, equipment and furniture are good examples of fixed assets. Tangibles are sometimes collectively referred to as ‘plant’.

Fixed assets are shown at Net Book Value (NBV) in the balance sheet – ie after accumulated depreciation. If I buy a machine for £20,000 and depreciate it at £4,000 per year, then after 2 years, the NBV would be: £12,000 (£20,000 – £4,000 depreciation each year).

Current assets are assets that can be converted into cash easily or are likely to be converted into cash within one year. Examples include:

  • cash
  • inventory and WiP
  • accounts receivable
  • shares in publicly-traded companies
  • prepayments – payments made before value has been received by a company

 

Wip is Work in Progress – raw materials that have had value added. The value of WiP should include the costs incurred – so the cost of, for example, direct labor moves from the Income Statement to the Balance Sheet.

As costs are lower, profits will be higher.

Current liabilities are amounts owed and due for repayment by the company within a year, for example:

  • accounts payable (money owed to creditors)
  • accruals – amounts owed at the end of the period but not yet recorded. An energy bill may only arrive after the end of the period for energy already used. The cost of the energy used should be placed in the period to which it relates and so an accrual is made. Thus an accrual represents the value of an invoice that we have yet to receive for expenses relating to current trading.
  • short-term loans
  • declared dividends – a dividend becomes an actual liability on the date of declaration
  • tax payable in the coming year

It is normal to place current liabilities next to current assets on the balance sheet, allowing one to see the net current position.

Amounts owed by the company and not payable within a year. For instance:

  • notes and bond loans – to raise money a company may issue a bond. In return for cash the company agrees to pay the bond holder a rate of interest for a period of time until the bond is redeemed and the bondholder’s money is returned. The company is thus acting like a bank – and hopefully paying less in interest than it would to a bank (or obtaining funds that it could not otherwise obtain)
  • long-term loans – when a long-term loan becomes payable within the next year, it will be shifted to current liabilities, usually with some indication that it was a long-term debt.

They are the profits after all deductions have been made. The earnings are retained by the company and can be used to fund future trading and investment. The retained earnings figure on the Balance Sheet is a cumulative figure – it represents all earnings that have not been returned to shareholders. 

Since they ‘belong’ to the investors, they sit under Owners’ Funds.

On the right, Current Liabilities has been moved under Current Assets so that we can easily see the Net Current Position.