The BS shows:
• the net worth of a business at a single point in time
• the owners’ equity.
Net worth is the difference between a business’s assets and its liabilities.
Therefore, another name for net worth is net assets. Owners’ equity is the
claim on the business by the owner(s). It consists of the original capital
invested in the business by the owner(s), and any profits (or other changes
in value) that the business has made in the past which have been retained,
or reinvested, in the business. These retained profits (or other changes in
value) are known as reserves.
Because the BS ‘balances’, the net worth and the owners’ equity should be
equal. This is known as the balance sheet equation:
Net Worth = Owners’ Equity
We can use the definitions of net worth and owners’ equity to rewrite this
equation as follows:
Assets – Liabilities = Capital + Reserves
There are many possible definitions of an asset but the usual definition is
something which the business owns or controls and which will provide
cash or other benefits in the future. Examples of assets are pieces of
machinery, computer equipment, goods for resale (stock), cash and
customers which owe the business money (debtors). Assets which are
expected to be held for more than one year are called fixed assets,
whereas cash or other assets which are expected to become cash within
one year are called current assets.
Liabilities are, at their simplest, amounts that a business owes. Generally,
at some point in the future it is probable that the business will have to pay
out cash or other benefits as a result of a past transaction or event.
Examples of liabilities are loans from the bank, and money owed to
suppliers (creditors). Similarly to assets, liabilities which will not be paid
for at least one year are called long term, whereas those that will be paid
in less than one year are called current. You may also find items called
provisions in a balance sheet. These are either used to make reductions in
the value of an asset, or for liabilities where the amount or timing of the
payment is uncertain.
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