The statement of financial position of a business sums up its economic resources, obligations (debts and other non-current liabilities) and owners’ capital at a particular point of time. It also shows how the economic resources contributed by lenders and shareholders are used in the business.
Balance sheet items are classified as assets, liabilities, or capital, and the amount and nature of these items are shown at a specific date in time.
Assets – Something the company owns that has value.
Liability – Money the company owes to creditors.
Capital – This is the portion that remains after liabilities are subtracted from assets. Capital includes profit or Loss from the business.
Drawings – Represent assets taken out by owners of the business
The Balance Sheet:
Reflects a Moment in Time
It indicates Assets, Liabilities and Equity of business as of a specific date.
Shows Financial Position of Business as of specific date:
Financial Position – what you have/what you owe/what your stockholders have “Have” – “Owe” = “Value to Owner”
Value of Business to Owners
Assets – Liabilities = Capital
The effect of Net Profit or Net Loss on the Balance Sheet
In the balance sheet net profit is added to capital because profit increases capital. It also follows that in net loss will be subtracted from capital because a loss will reduce the owners capital.
This is the excess of current (or short term) assets over current (or short term) liabilities. To calculate working capital the total of Current liabilities is subtracted from the total of Current assets.
Working Capital may be used as a tool for solvency. The calculation involves strictly short term items and therefore working capital reveals the assets of the business that are most easily converted to cash in the short term. This has significance for the liquidity or solvency of the business or its ability to deal with short term payments. In the long run fixed assets may be sold to offset immediate cash obligations.
The calculation of working capital