A Balance Sheet gives you a snapshot of the financial state of your business at a given point in time. It is used to assess the value of your business and to work out the ratios which evaluate business performance. This section gives you an overview of the Balance Sheet and also explains the most helpful ratios for your business.
2. A snapshot of your business
A Balance Sheet gives a snapshot of the financial state of your business at a given point in time. It shows what your business owns or is owed (assets) and what it owes (liabilities) at a particular date.
It is used to assess the value of your business and is one of the first things a potential investor or bank manager will want to see.
Limited companies must produce a Balance Sheet as part of the annual accounts they submit to Companies House, HM Revenue and Customs and their shareholders.
Sole traders are not required to submit formal accounts and a Balance Sheet on their tax return. However as financial details do have to be entered on the tax return in a particular format, it can be useful to prepare the figures in a Balance Sheet format.
Your accountant can help you prepare a Balance Sheet, although it is important that you understand what it means.
3. Balance Sheet at a glance
Here is an example Balance Sheet.
|Short Term Debtors
|Total Current Assets
|Total Current Liabilities
|Long Term Liabilities
|Less Accumulated Depreciation
|Total Long Term Liabilities
|Total Fixed Assets
|Total Liabilities and Equity
4. Using ratios to assess business performance
Ratios are a quick and simple way to evaluate business performance. A ratio is expressed as a proportion of something else. For example, we talk about a car’s performance in terms of miles per gallon. If a car was doing 40 miles per gallon (40:1) in its first year, but only 25 to the gallon this year (25:1), you would be disappointed and would examine why.
In just the same way, accounting ratios can provide a valuable insight into your business performance. The figures are taken from your Balance Sheet.
There are 2 key ratios that are important:
Liquidity Ratio – this shows the business’s ability to pay short term creditors out of its total cash.
These figures come from the Balance Sheet. A ratio between 1.8 and 2.2 is considered a safe zone.
Current Assets £20,000 = 2:1
Current Liabilities £10,000
Profitability Ratios – this shows how profitable the business is. These figures come from your Profit and Loss Account.
Gross Profit Margin measures gross profit as a percentage of sales.
In some industries, you can compare your gross profit margin with the industry standard.
Net Profit Margin measures net profit as a percentage of sales.
This will get higher as the financial position of your business improves.
Gross Profit x 100 Net Profit x 100