Understanding the Balance Sheet
What Is a Balance Sheet?
A balance sheet forms part of a company’s annual accounts and shows the financial position of the company at a specific point in time (usually the company accounting year end).
It sets out three key things:
• What the company owns (assets)
• What the company owes (liabilities)
• What remains for shareholders (equity)
In simple terms:
Assets – Liabilities = Equity
Or put another way, what the company owns minus what it owes equals the value belonging to the company’s shareholders.
For UK limited companies, the balance sheet is included in the statutory accounts filed with Companies House each year.
Assets – What the Company Owns
Assets represent items the company owns or amounts owed to the company that have value.
Assets are normally divided into Current Assets and Non-Current Assets.
Current Assets
Current assets are expected to turn into cash within the next 12 months.
Typical examples include:
• Cash in the business bank account
• Money owed by customers (trade debtors)
• Closing stock
• Prepayments (for example insurance paid in advance)
Current assets are useful for understanding the company’s short-term financial position.
Non-Current Assets
Non-current assets are longer-term assets used by the business over time.
Examples include:
• Computers and office equipment
• Vehicles
• Machinery
• Long-term loans owed to the company
These assets help the business operate but are not normally converted into cash in the short term.
Liabilities – What the Company Owes
Liabilities represent amounts the company owes to other parties.
These are also split into Current Liabilities and Non-Current Liabilities.
Current Liabilities
Current liabilities are amounts due within the next 12 months.
Common examples include:
• Supplier bills (trade creditors)
• VAT owed to HMRC
• Corporation Tax payable
• PAYE and National Insurance payable
• Loan repayments due within 12 months
• Directors loan balances owed to directors
• Accruals (expenses relating to the year but paid after the year end)
These figures are important when assessing whether the company can meet its short-term obligations.
Non-Current Liabilities
Non-current liabilities are amounts due after more than 12 months.
Examples may include:
• Long-term business loans
• Long-term lease commitments
Equity – The Value Belonging to Shareholders
Equity represents the value remaining in the company once liabilities have been deducted from assets.
Equity may include:
• Share capital – the value of shares issued
• Retained profits – profits kept in the business over time
• Other reserves where applicable
This section effectively shows how much value the company has built up (or lost) since it was formed.
Why the Balance Sheet Matters for Business Owners
Many directors focus mainly on profit. However profit alone does not show the full financial position of a business.
The balance sheet helps you to:
• Understand whether the company can pay its bills
• See how the business is funded (loans, directors loans or retained profits)
• Check whether profits are supported by cash in the bank
• Identify potential financial risks early
A company can be profitable but still run into difficulties if the balance sheet is weak, usually due to cash flow issues.
Simple Balance Sheet Example
Imagine a company has:
£50,000 in the bank
£10,000 owed by customers
Total assets: £60,000
The company owes:
£15,000 to suppliers
£5,000 in VAT
Total liabilities: £20,000
This leaves equity of £40,000.
In simple terms, if the company paid off all its debts today, £40,000 would remain for the shareholders.
Final Thoughts
The balance sheet provides a snapshot of a company’s financial position at a specific point in time.
Once you become familiar with it, the balance sheet can provide useful insight into how a business is funded and whether it is financially stable.
If you would like help understanding your company accounts or balance sheet, then you can email me at will@matrixaccountancyservices.com or call 01788 486065.