Concepts

Introduction

Why?

You know that a business will often owe money to various individuals or institutions. It might owe its suppliers money for a recent delivery, the bank for an overdraft or loan and it holds money that was invested by the owners/shareholders.

The balance sheet helps us look at the debt position of the business and allows us to see whether or not it is financially secure. For instance, a business that had most of its debts in the form of an overdraft that had to be paid by the end of the month is in a worse liquidity position than one that has its debts in the form of a loan that doesn't have to be paid off for five years.

We can also look at what the business owns. These items, known as assets, can be used to pay-off any debts and maintain liquidity.

Balance?

This account gets its name from the fact that everything the business has is equal in value to everything that it owes.

A business does not really exist in the same way that people do. Everything the business has, was paid for by money that either came from banks or from investors or other sources. If everybody knocked on the door of the business and demanded the money that was theirs, the banks would get their loans repaid, the investors would get their shares plus profit and the suppliers would get the money that was owed to them (trade credit). To pay everyone in full, the business would have to sell all of its assets - its property, its stock and even its paper-clips.

Assets = Liabilities + Capital