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WARNING: If you have studied accounting, business, economics, finance or banking; please by all means, ignore this post because it will bore you to death.
ello there scholars. Before you read this, you ought to read the prerequisite post titled "Accounting for Dummies Part 1" where we discussed about how the performance of a business is captured, measured via the following indicators, ie the components of Profit and Loss Statement a.k.a the Income Statement, that are normally recorded for a financial year of 12 months:• Revenue
• Gross profit
• EBITDA
• Depreciation and Amortisation
• Profit Before Tax (PBT)
• Profit After Tax (PAT)
• Earnings Per Share (EPS)
• PATAMI
At the end of a financial year (most companies use 31 December as the end date for a 12 month period of 1 January to 31 December), a take stock of the wealth position of a business helps you to decide what course of actions you need to take. This 'take stock' is presented in what we call the Balance Sheet.
What is a Balance Sheet? Using our example of a sandwich parlour, we probably have the below in our Balance Sheet:
BALANCE SHEET AS AT 31 DECEMBER 2009
EQUITY
Share Capital = RM300
Profit Reserve = RM500
TOTAL EQUITY = RM800
Represented by:
ASSETS
Tangible Assets - Toaster
~ Cost = RM100
~ Accumulated Depreciation = (RM50)
Intangible Assets - License
~ Cost = RM100
~ Accumulated Amortisation = (RM33)
Investment in a Subsidiary = RM100
Cash = RM588
TOTAL ASSETS = RM800
Based on the initial example in Part 1, you have invested RM300 (contribution as Share Capital) of your money to start the business: RM100 on toaster(s), RM100 fee for a 3-year license and say RM100 for the bakery of which, these are recorded as Tangible Assets, Intangible Assets, and Investment in a Subsidiary respectively. Having spent all these and operated the business for a year, you achieved Profit After Tax of RM500. So your wealth is now at RM800, ie the Invested amount of RM300 plus the profits of RM500, referred to as EQUITY. EQUITY is an accounting jargon. For a non-accountant like you, what does that really mean?
Well, what you really want to know is what you have now in your hands that make up that RM800. You own toaster(s) which cost you RM100 but since you have depreciated RM50, the net book value is now RM50. You also have the right to conduct a sandwich business by virtue of obtaining the 3-year license that costs you RM100 but now at net book value of RM67 after amortising RM33. You also invested RM100 acquiring a bakery business. As a result of selling sandwiches, your profit after paying all expenses, taxes and charging depreciation and amortisation stood at RM500.
Bare in mind there are 2 expenses which really did not result in you paying hard cash - they are depreciation of the toaster(s) and amortisation of the license. So really, the cash that you have is the RM500 profit plus RM50 depreciation and RM33 amortisation, giving you actual hard cash of RM588 which you really got from collection from customers less payments for expenses such as bread, tuna, cheese, electricity and rental. The 4 assets that you have, ie toaster(s), license, bakery business and cash adds up to the RM800 = the EQUITY you have to date. So this equation of ASSET = EQUITY, a perfect equilibrium, is what transpired the name "Balance Sheet", ie A sheet that balances!
That was an illustration of a simple Balance Sheet for our sandwich business. In real life, it's more complicated than that. You'd probably have your cash in a bank and some in hard cash. You'd probably have some customers who still owe you money that was not yet collected as at the Balance Sheet date. You'd also probably have some suppliers whom you have not yet paid such as electricity whereby the bill may still be unpaid as at Balance Sheet date. All these will make your Balance Sheet looks more extensive. What is even worse, you will classify these items between 'Current' and 'Non Current'. The former normally gets settled (collected or paid) within 12 months and the latter is the opposite, ie beyond 12 months. The typical components of a Balance Sheet are as follows:
EQUITY (E)
• Share Capital
• Share Premium Reserves
• Asset Revaluation Reserves
• Foreign Currency Translation Reserves
• ESOS Reserves
• Warrant Reserves
• Retained Earnings / (Accumulated Losses)
• Minority Interests
• Equities and Reserves Attributable to Shareholders
Represented by:
NON CURRENT ASSETS (NCA)
• Investment in Subsidiaries
• Investment in Asscoiates
• Investment in Jointly-controlled Entities
• Other Long Term Investments
• Intangible Assets
• Property, Plant and Equipment
• Long Term Prepaid Lease
• Long Term Receivables
• Long Term Deferred Expenditure
• Other Long Term Assets
Add CURRENT ASSETS (CA)
• Cash on Hand
• Cash at Financial Institution
• Short Term Investments
• Trade and Other Receivables
• Inventories
• Short Term Prepaid Lease
• Short Term Deferred Expenditure
• Assets Held For Sale
• Tax Recoverable
• Deferred Tax Assets
• Financial Derivative Assets
• Other Short Term Assets
Less CURRENT LIABILITIES (CL)
• Trade and Other Payables
• Overdrafts
• Tax Payable
• Deferred Tax Liabilities
• Borrowings (payable within 12 months)
• Hire Purchase and Leases (payable within 12 months)
• Short Term Deferred Income
• Financial Derivative Liabilities
• Other Short Term Liabilities
Less NON CURRENT LIABILITIES (NCL)
• Borrowings (payable beyond 12 months)
• Hire Purchase and Leases (payable beyond 12 months)
• Long Term Deferred Income
• Other Long Term Liabilities
The above Balance Sheet components sound more advanced and complex. For your purpose, I will, later, guide you on what are the critical ones that you really need to know and what you can get away with by saying "have no idea,... am not an Accountant". The earlier equation of ASSET = EQUITY now seems to have unbundled into more components, which, in general, is as follows:
E = NCA + CA - CL - NCL
Note:
E = Equity
NCA = Non Current Assets
CA = Current Assets
CL = Current Liabilities
NCL = Non Current Liabilities
Current Assets less Current Liabilities gives you Net Current Assets or Net Current Liabilities depending on whether you are in an asset surplus position or deficit. Another name for this net current position is "Working Capital" suggesting that these are the immediate Balance Sheet items that you manage within a year as and when you proceed in your daily business operation. From overall perspective, really, your Equity is in fact the net of all your Assets and Liabilities. Henceforth, these equations listed below can be used interchangeably:
E = NCA + Net Current Asstes/(Liabilities) - NCL
E = NCA + Working Capital - NCL
E = Total Assets - Total Liabilities
E = Net Assets/(Liabilities)
E + CL + NCL = NCA + CA
E + Total Liabilities = Total Assets
We shall continue analysing Balance Sheet in a more micoscopic manner in Part 3 and subsequent Parts. Until then, I hope Part 1 & 2 of "Accounting for Dummies" serve as a catalyst to your interest in learning further.
* kopihangtuah
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