A blog by Thomas Steed
This is the second part of my two-part series of blogs explaining accounting jargon! If you missed the first part where I covered off the different terminology you might see on the profit and loss account, please go back and read that too. Part 1 can be found here.
This second part is going to cover off the different terminology you might see on the balance sheet, which, along with the profit and loss account, is one of the reports you will see in every set of accounts you receive.
Balance sheet
This is essentially a snapshot in time showing the financial position of your business. This snapshot is taken at your accounting year end, and this report will contain your capital assets, your debtors, the cash and bank balances you held, as well as your creditors at that date. All these together equal the equity remaining within your business at the end of that accounting year. I’ve used a lot of accounting jargon in here so I will explain all of these below!
Capital Assets
These are the larger purchases you make within your business, for items you are going to use in your business for a number of years. This could be a vehicle, a piece of machinery, a computer, a building, anything that you will use for more than 12 months within your business.
You might also see them called tangible assets or fixed assets, but they all mean the same thing.
Depreciation
We can’t just show the capital assets in your accounts at the price you paid for them. The value of these items will decrease over time and we need to reflect that decrease within your accounts. (There are exceptions to this but generally, for the majority of assets, they will reduce in value). As an example, we all know that the second you buy a new vehicle and drive it off the forecourt the value of that vehicle is drastically reduced, but how can we show that in the accounts?
That’s where depreciation comes in, we will use an appropriate rate based on the type of asset we are depreciating and reduce the value of those assets to reflect a real-world picture of what that asset might be worth should you try and sell it.
This is a cost to the business, so depreciation is shown as an expense in your profit and loss. Tax relief on assets generally happens when you purchase the asset, so depreciation is not allowable for tax purposes as otherwise we would be doubling up on tax relief on the same asset.
But why does it matter? Why do we need to bother showing this reduction in value in your accounts? Well, legally this is an adjustment that must be made to reflect an up-to-date value of the assets in your accounts. But also, without this depreciation adjustment, the value of those assets will be overstated, and the accounts will give an inaccurate picture of the value and health of your business.
Say someone wanted to come and purchase your business from you, they would look at your accounts to get an idea of what the business was worth and how much they should offer you. If for example your balance sheet showed vehicles of £100,000 for some vehicles that you purchased a long time ago, all they would see in the accounts would be the £100,000 of vehicles, which would dramatically increase the price they would offer for your business, but they would be mightily disappointed when they discovered these were just a few old bangers which were worth next to nothing!
Debtors
Debtors are amounts that are owed to you, usually by your customers where you have sold them something on credit, but the debtors figure in your accounts will contain anything that is owed back to you at your year end. The debtors balance will be shown in the current assets section of the balance sheet.
Why are these included? Well, these amounts won’t show in the bank balance as you hadn’t received payment by the end of the year, but they are amounts that were due to you that you will hopefully have received shortly after the year end, so they need to be included to give a fair and accurate representation of the financial position of the business at the year end.
Creditors
Very simply, these are amounts that you owed to someone else at the year end. This could be a balance owed to a supplier, a VAT/PAYE/corporation tax bill owed to HMRC, the remaining portion of a loan owed back to a lender at the year end, etc.
The creditors balance is split in your accounts between current and long-term creditors. This will be shown in your accounts as balances due to creditors within 1 year of the year end under the current assets section of the balance sheet, with amounts owed to creditors due in over 1 years’ time shown further down in their own section.
The reasoning for including these is very similar to the reason as to why we include the debtors figure in the accounts. They are amounts owed by your business that will have to be repaid at some point in the future, so if we don’t show these in the accounts we wouldn’t be giving a true reflection of the financial position that your business is in.
Current assets
I mentioned that debtors and creditors due within 1 year are included in the current assets section of your balance sheet, but what does that mean?
Very simply, the current assets section of your balance sheet shows the assets that will very quickly turn into cash in your bank account, or the liabilities that will soon need to be paid by your business.
The net current assets total, usually found around halfway down your balance sheet, gives you an idea of the health of your cash position in your accounts. This will be calculated by totalling all the stock you held, the debtors who owed you money and any physical cash or bank balances held at the year-end and subtracting the creditors who you owe money in the near future.
As you can see, all of these will usually become cash that is either received or paid out soon after the end of the year. Stock usually has quite a quick turnaround time before it’s sold, you will hopefully receive payment from your debtors relatively quickly and your creditors will want payment before long.
Equity
The bottom of your balance sheet will look different depending on whether you trade through a limited company, through a partnership or as a sole trader, but you should see one of the following: profit and loss reserves, current accounts, or capital account.
These all essentially mean the same thing – it’s the business’s book value, the difference between the total assets less the total liabilities. It could also be thought of as the value that the owner of a business has left over after all the business’s liabilities have been deducted.
I hope this guide has helped clear up a few questions or made reviewing your accounts just that little bit easier. If you do have any questions about your accounts or anything else we’ve told you please feel free to get in touch with us, just pick up the phone (01284 755956) or send your client manager an email and we’ll be more than happy to answer any questions you have.
