Having produced the profit and loss account for the period, it is now possible to prepare a Balance Sheet for the period. On its own, the Profit and Loss Account is an incomplete record of a business’s financial position as it only records two income and expenses. The Balance Sheet will record the situation of the business in respect of asset, liability and capital accounts from the trial balance.
The Balance Sheet differs from the Profit and Loss Account as it is a snapshot that is only relevant on a given date. The date at the top of a Balance Sheet is the last day of the accounting period to which it relates. The heading of a balance sheet always contains the words “as at” a specified date. That balance could be different the very next day, if for example, an asset was sold and the proceeds used to pay bills.
The Balance Sheet principally indicates:
- the net worth or net asset value (‘NAV’) of the particular business (i.e. the value of the assets it has, less the liabilities it owes). This is recorded in the top half of the Balance Sheet; and
- the capital invested in the business to achieve that net worth. This is recorded in the bottom half of the Balance Sheet.
These figures will always be the same, unless something has gone wrong. The two halves of the Balance Sheet must always ‘balance’. This ‘balancing effect’ is because the top half of the Balance Sheet demonstrates how the money invested by the owners of the business has been used.
As a general rule, asset, liability and capital entries from the trial balance are transferred into the Balance Sheet. For example, ‘debtors’ in the trial balance is an asset and this appears in the top half of the Balance Sheet. Compare this to ‘capital at the start of the year’, which is a capital entry and appears in the bottom half of the Balance Sheet.
In my next post, I will present an example of a Balance Sheet, together with notes regarding it.