Do Now - Define the following key terms

CREDITOR

LIABILITIESDEBTORS

LIQUIDITY

WORKING CAPITAL FIXED COSTS

VARIABLE COSTSGROSS PROFIT

SHAREHOLDERS

STAKEHOLDER

Using financial data to measure and assess performance (Part 3)

By the end of this lesson you should be able to:

1. Understand the structure of a balance sheet.

2. Understand how balance sheets are used to assess performance and potential.

3. Understand how to select, calculate and interpret financial ratios to assess performance.

Learning Objectives

where money has been spent

where money

came from

all assets

all liabilitiesmust equal

must equal

Accurate balance sheets must obey the following principle:

Which means that:

Why is it so crucial assets and liabilities balance?

Basic principles of a balance sheet

1) Non-current assets (fixed assets)

Fixed assets are those which the business actually owns and which are therefore ‘fixed’ into the company.

Include buildings and furniture fittings, machinery and company vehicles.Cost a lot of money and represent a large investment for

the business.last for a long period of time.Can be sold to increase capital (i.e. the money invested in the business).

Fixed assets are those that have a useful life in excess of one year.

For example:

A shop, the value of the stock is a current asset.

An interior designer working on a job for a client, the work in progress is a current asset.

2) Current assets

Current assets are those which the business holds temporarily or that are always changing on a day-to-day basis. Including inventories (stock), cash or trade receivables (debtors).

The final main types of current asset are customers who owe money for goods bought Trade Receivables (debtors) and also the amount of money in a company’s current bank account.

Current liabilities, like current assets, are short-term and always changing. However, this is money that a business actually owes.

short-term loans

Trade Payables (Creditors)

bank overdrafts

share dividend payments.

Current liabilities are those that are expected to be paid back in one year.

3) Current liabilities

Common current liabilities include:

Non-Current liabilities relate to money owed to be paid back over a longer period of time.

Mortgages

Loans

4) Non-current liabilities (Long term liabilities/ loans)

Common non-current liabilities include:

Current liabilities are those that are to be paid back over a longer period of time.

Asset or liability?

5) Total Equity

The total amount if money being utilised in the business from share capital and retained profit.

Why is the money personally invested by a business a liability and not an asset?

Share capital – money which shareholders have invested in the business.

Reserves – profit from previous years which has been retained to finance future developments.

Profit and loss account – money kept back from the current year’s profits (the net profit).

Let’s look at the structure of balance sheets

Practice!Although you won’t need to create a balance sheet in an examination it is good for you to understand how they

work.

Both the balance sheet and the profit and loss account show the ‘health’ of the business.

Shareholders, customers, suppliers, employees and other stakeholders will be interested in both types of account.

Reading a balance sheet

They will want to see how the business is getting its money (e.g. whether it is borrowing large amounts of money or whether it is using profits) and how well and on what this money is used.

Important balance sheet considerations

It is important for companies to bear in mind the following considerations when preparing balance sheets:Fixed assets – is there enough money secured in items

which could be sold to raise capital? Or is there too large an investment in fixed assets and not enough liquidity (the ability to meet current liabilities) in the business?

Cash in bank – can a short-term crisis be covered?

Net current assets/liabilities – if this figure is negative, the business hasn’t enough money to pay all its debts in a reasonable time, if required.

Shareholders’ funds – are these increasing? Shareholders will want their investment to grow.