How does a balance sheet balance?

A balance sheet matches net assets to equity, which should never be in deficit. The next most important feature is positive net current assets.

Balance Sheet Net Assets and Equity

The net worth value of a balance sheet is recorded as net assets balanced against equity. A positive balance sheet forecast is the major component of any successful business plan.

Total assets less total liabilities, including contingent liabilities and provisions represent net assets. These are matched by equity, such issued share capital, retained earnings after tax, share premium account if applicable and other capital items ultimately due to the shareholders of the company – Hence balance sheet.

There are two classes of asset in the balance sheet; current and non-current. 

Current Assets

Current assets represent cash, cash convertibles arising solely from core trading i.e. accounts receivable to be collected within one year and prepayments such as annual insurance policies.

These are key items for any a balance sheet forecast because current assets less current liabilities (i.e. payable within one year) represent working capital, which in turn describes balance sheet liquidity. Deficits are not recommended.

Non-Current Assets

Non-current assets represent fixed assets at net book value (i.e. cost less depreciation), intangibles (e.g. depreciated cost of temporary right of use patents or licencing rights). the value of investments unconnected with core trading such as shares in third party companies or interest earned.

Current Liabilities.

Thiese are liabilities, that are going to be payable within one year.

The bank overdraft is always classed as a current liability. That is because it is payable on demand. Informal loans that are not covered by contracts specifying repayment dates are also classed as current liabilities.

Long Term Liabilities in the Balance Sheet

Long term liabilities are not included as charges to current assets when calculating working capital, which is why any intended loans for more than a year to a business by its directors for example should be accompanied by a formal contract, making that clear.

If not they will be classed as current and therefore deducted from forecast working capital. 

Balance Sheet Equity

Attributable to shareholders, equity is principally made up of paid-up share capital, retained profits after tax and perhaps a share premium account. Note that a balance sheet forecast showing equity in deficit predicts technical insolvency.

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