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What a business owns and is owed, less what it owes, on one stated date, why a loan-funded purchase leaves the owner's interest where it was, and the current and acid-test ratios.
Paper packet. Every task here also exists on screen, where it is checked automatically; answers written on paper are not assessed by Nydus. When you are back at a device, enter your answers there.
You will build a balance sheet for one date — assets, liabilities and the owner's interest between them — tell what belongs on it from what describes a period instead, and follow a loan-funded purchase through both sides. You will also read the sheet's current and acid-test ratios for whether its near-term debts can be met.
The income statement answered a question about a month. Working capital looked at what the business has and owes in the month ahead. The balance sheet widens that to everything it has and owes, on one date: the van and the fit-out as well as the cash, the whole of the loan as well as this month's installment. You already have every piece of arithmetic it needs; the new skill is deciding what is on the photograph at all, and reading the two sides against each other.
| Term | What it means |
|---|---|
| Assets | What the business owns or is owed: cash, unpaid invoices, stock, equipment. |
| Liabilities | What the business owes: suppliers, a loan, tax due. |
| Owner's interest | Assets less liabilities: the part of the business that belongs to its owner. |
| Current assets | Assets that turn into cash within a year. |
| Current liabilities | Liabilities that must be paid within a year. |
| Current ratio | Current assets divided by current liabilities. |
| Acid-test ratio | Current assets without the stock, divided by current liabilities. |
The income statement is a film of a month. The balance sheet is a photograph taken on one date, and it answers what does the business own, what does it owe, and what is left for its owner?
$$\text{owner's interest} = \text{assets} - \text{liabilities}$$
It is called a balance sheet because the two sides always agree: everything the business has was paid for by somebody — by a lender, by a supplier who has not been paid yet, or by the owner. Write the formula the other way round and it says exactly that: assets = liabilities + owner's interest.
That is why borrowing to buy something does not make an owner richer. Buy a 3000-dollar oven with a 3000-dollar loan and assets rise by 3000, liabilities rise by 3000, and the owner's interest does not move. The business is bigger. The owner is not better off until the oven earns more than it costs.
And a photograph has no time in it. A month's sales, a month's rent or a month's profit are not on a balance sheet at all; their effect shows up only as a different amount of cash, stock or debt on the date.
Another way: steps
Another way: table
Corner Bean on 30 June, in dollars.
| Assets | Liabilities | ||
|---|---|---|---|
| Cash | 1800 | Owed to suppliers | 1200 |
| Owed by customers | 600 | Fit-out loan | 2000 |
| Stock | 500 | Total | 3200 |
| Espresso machine and fit-out | 5600 | ||
| Total | 8500 | Owner's interest | 5300 |
8500 − 3200 = 5300. The first three assets are the ones working capital counts; the machine is kept to use, not to sell.
Fix the date. Everything on the sheet is as it stands at the close of that one day. A balance sheet without a date cannot be read.
List the assets. Cash in every account and the register; every unpaid invoice owed to the business; stock at cost; equipment, vehicles and fittings at their value in the books; any deposit paid that will come back.
List the liabilities. Every supplier bill received and not paid; what is left on each loan — the whole of it, not only this month's installment; tax collected or owed and not yet paid; deposits taken from customers for work not yet done.
Subtract. Assets less liabilities is the owner's interest.
Leave out every figure for a period. Sales, rent, wages and profit for the month describe a film, not a photograph. Their effect is already in the cash, the stock and the debts on the date.
Check the sheet by the balance itself: liabilities plus owner's interest must equal the assets. If last month's sheet is available, check the change too — the owner's interest should have risen by the month's profit, plus anything the owner put in, less anything the owner took out. A difference that cannot be explained that way is a missing asset or liability.
The balance sheet also answers a narrower question than the owner's interest: can the business pay what falls due in the coming year out of what will turn into cash in the same year? Two ratios answer it, and both use only the current lines.
$$\text{current ratio} = \frac{\text{current assets}}{\text{current liabilities}}$$
A current ratio of 2 means two dollars of cash, invoices and stock for every dollar due within the year. Below 1, the business owes more in the near term than its current assets could pay even if all of them turned into cash.
$$\text{acid-test ratio} = \frac{\text{current assets} - \text{stock}}{\text{current liabilities}}$$
The acid test takes the stock out, for the same reason the working-capital lesson did: stock pays nothing until it is sold. A shop with a current ratio of 2 and an acid test of 0.6 can pay its near-term debts only if its shelves empty in time.
Neither ratio has a correct value for every business. A café that sells for cash can run safely on a low ratio; a wholesaler that waits sixty days for customers needs a higher one. What matters is the trend, and the gap between the two ratios, which is the stock.
Most transactions change two lines of the balance sheet and leave the owner's interest alone: buying stock for cash, collecting an invoice, borrowing, repaying a loan, buying equipment on credit. Each swaps one asset for another, or adds or removes an asset and a liability together.
Only four things move the owner's interest. Profit raises it and a loss lowers it, because trading turns assets into more (or fewer) assets. The owner putting money in raises it. The owner taking money out — drawings — lowers it. So the owner's interest at the end of a year is the start, plus the year's profit, plus money put in, less drawings. When an owner asks where the year's profit went, the balance sheet has the answer: into more equipment, more stock, less debt — or out as drawings.
Every asset on a balance sheet is shown at a figure, and the figure is not always what the asset would fetch on the date.
Cash is exactly what it says. Invoices owed are shown at what the customers owe, less any the business has stopped expecting to be paid. Stock is shown at what it cost, or less if it has spoiled or will only sell at a loss — never at its selling price, because the profit on it has not been made. Equipment is shown at what it cost, less the part of that cost already charged against profit as the equipment wears out; that charge is called depreciation, and a later lesson works it out.
So the owner's interest is a figure from the books, not a price anyone would pay for the business. A café with a well-known name and loyal customers may be worth far more than its balance sheet says; a shop with shelves of dated stock may be worth less. The balance sheet is still the right place to start, because every figure on it can be checked against a receipt, an invoice or a count, but a buyer, a lender or the owner reading it should ask of each large asset what it would really fetch, and of each liability whether anything is missing.
The balance sheet also lets an owner ask what the money tied up in the business is earning. The return on the owner's capital is the year's profit over the owner's interest, as a percentage: a salon whose owner has 40,000 in it and which made 6,000 of profit in the year returned 15 percent. A wider measure, return on capital employed, puts the operating profit, before interest, over the owner's interest plus the long-term loans, because both kinds of money are funding the business.
The figure is worth comparing with what the same money could earn elsewhere, in savings or paying off a mortgage, and with the risk the owner is carrying. A business that returns less than a savings account on the owner's capital is paying its owner mainly in wages for the hours they work, which may still be a good bargain, but should be known. Like every ratio, it is read against the same business's earlier years and against similar businesses, never on its own.
A bakery asks its bank for a 20,000-dollar loan to buy a second oven. The bank asks for the latest balance sheet, dated 31 December: cash 4,000; owed by cafés 6,000; flour and packaging 5,000; ovens, mixers and the van 48,000. It owes suppliers 7,000, tax 1,000, and 30,000 on an existing loan, of which 6,000 falls due in the coming year.
Assets total 63,000 and liabilities 38,000, so the owner's interest is 25,000. Current assets are 4,000 + 6,000 + 5,000 = 15,000; current liabilities are 7,000 + 1,000 + 6,000 = 14,000. The current ratio is 15,000 ÷ 14,000 ≈ 1.07, and the acid test, without the flour, is 10,000 ÷ 14,000 ≈ 0.71.
The bank's officer reads three things. The owner has 25,000 of her own interest in the business, which is a good sign. The new loan would raise assets and liabilities by 20,000 each and leave that interest unchanged. But the acid test below 1 says the bakery already relies on selling its stock and collecting from cafés to meet the coming year's debts, and a new loan adds its own repayments to the current liabilities.
The bank offers the loan over seven years rather than five, which keeps the yearly repayments smaller, and asks the owner to collect from cafés on thirty days rather than the forty-five they now take. Both answers come straight off the sheet.
Companies in many countries must file a balance sheet each year with a public register, and anyone can read it. Suppliers use it before giving credit, and competitors use it to see how a rival is funded. The layout varies, but the lines are the ones in this lesson: current and non-current assets, current and non-current liabilities, and the owners' interest, often called equity.
The balance sheet explains the month. It shows one date. How the business got there is on the other two statements.
Owner's interest is cash the owner can take. It is a difference between two totals, most of which may be equipment and stock. It is not a pile of money anywhere.
A purchase on a loan makes the business worth more. Both sides rise by the same amount; the owner's interest does not move.
A large total of assets means a healthy business. Much of it may be owed to a bank. Read the liabilities beside it.
A good current ratio means cash is plentiful. It may be mostly stock. Read the acid test beside it.
The owner's interest is what the business would sell for. It is a figure from the books; a buyer pays for what the business will earn.
Read the sheet on 31 March: assets 11,000, liabilities 6,500.
$11000 - 6500 = 4500$
The owner's interest.
Buy a 1,200 irrigation pump with cash on 1 April.
$\text{cash } -1200; \quad \text{equipment } +1200$
One asset turns into another.
Find the assets on 1 April.
$11000 - 1200 + 1200 = 11000$
The total does not change.
Find the owner's interest on 1 April.
$11000 - 6500 = 4500$
Exactly where it was.
Say what did change.
$\text{cash for next week's bills is } 1200 \text{ lower}$
The photograph balances; the working capital does not look the same.
Add the current assets: cash 800, invoices 1,500, stock 2,200.
$800 + 1500 + 2200 = 4500$
What turns into cash within the year.
Find the current liabilities: suppliers 1,900 and this year's loan payments 1,100.
$1900 + 1100 = 3000$
Only the part of the loan due within the year.
Work the current ratio.
$4500 \div 3000 = 1.5$
A dollar and a half for every dollar due.
Take the stock out.
$4500 - 2200 = 2300$
Cash and invoices only.
Work the acid-test ratio.
$2300 \div 3000 \approx 0.77$
Below 1: some screens must be used on paid jobs before all the near-term debts can be met.
Read the gap between the two.
$1.5 - 0.77 = 0.73$
Nearly half the cover is stock in the drawer.
Note the owner's interest on 1 January.
$4200$
From last year's closing sheet.
Add the year's profit.
$4200 + 9800 = 14000$
Trading turned assets into more assets.
Take off Alexa's drawings for the year.
$14000 - 8700 = 5300$
Money she took out for herself.
Compare with the sheet on 31 December.
$8500 - 3200 = 5300$
The closing sheet agrees.
Find how much the owner's interest grew.
$5300 - 4200 = 1100$
The profit kept in the business.
Say where it went.
$\text{loan down } 1000, \text{ cash up } 100$
The profit she did not draw paid down the fit-out loan.
Check that the loan repayment did not move it.
$\text{cash } -1000, \ \text{loan } -1000$
Repaying the loan swapped cash for less debt; it was the profit that raised the interest.
Add the liabilities.
$1400 + 3000 = 4400$
Everything the business owes.
Subtract from the assets.
$9600 - 4400 = 5200$
The owner's interest.
Check the balance.
The balance sheet of Corner Bean on 31 March, in dollars. Fill in the two totals and the owner's interest.
| Dollars | |
|---|---|
| Cash | 1400 |
| Owed by customers | 900 |
| Stock at cost | 600 |
| Equipment | 6000 |
| Total assets | |
| Owed to suppliers | 1300 |
| Bank loan | 2400 |
| Total liabilities | |
| Owner's interest |
Complete the worked solution: on 31 May a shop has $1600$ dollars of cash, $900$ owed by customers, $900$ of stock and $6300$ of equipment. It owes suppliers $900$ and the bank $1000$. Find the owner's interest and the assets that will turn into cash.
Add the four assets.
$1600 + 900 + 900 + 6300 =$ a
Everything owned or owed to the shop on 31 May.
Add the two liabilities.
$900 + 1000 =$ t
Everything it owes on the same date.
Subtract to find the owner's interest.
$(\text{assets}) - (\text{liabilities}) =$ o
The part of the assets nobody else has a claim on.
Add the assets that will turn into cash.
$1600 + 900 + 900 =$ k
The equipment is kept to use, not to sell.
Check the balance.
$\text{assets} = \text{liabilities} + \text{owner's interest}$
Everything the shop has was paid for by a lender, a supplier or the owner.
Fixit Mobile is drawing up its balance sheet for 31 March. Sort each item.
| An asset | A liability | Not on a balance sheet: a figure for a period | |
|---|---|---|---|
| Cash in the business account | |||
| Unpaid invoices to corporate clients | |||
| Replacement screens in the drawer | |||
| The soldering station | |||
| The parts supplier's unpaid bill | |||
| What is left on the van loan | |||
| March's repairs, $5036$ dollars | |||
| The rent paid for March |
On 30 June, Long Row Gardens has total assets of $10900$ dollars, total liabilities of $5900$ and an owner's interest of $5000$. The next day it buys a van for $1500$ dollars, paid for entirely with a new bank loan. Fill in the three figures the day after, in dollars.
| Amount | |
|---|---|
| Total assets the day after | |
| Total liabilities the day after | |
| Owner's interest the day after |
Long Row Gardens' assets on 30 June include $449$ dollars in the account, $594$ dollars owed by restaurants, trays of seedlings and a polytunnel. Put them in order of how soon each could pay a bill, soonest first.
Number the steps in order (write the number in the box):
A printing firm's balance sheet on 31 December shows cash of $600$ dollars, $200$ owed by customers, stock of $600$ and presses worth $28000$. It owes suppliers and the tax authority $800$ dollars, all due within the year. What is its current ratio?
Answer:
A hair salon lists these figures on 30 April, in dollars: cash $600$; gift vouchers owed by a hotel that resells them $400$; hair products for sale $900$; chairs, basins and dryers $4900$; owed to the product supplier $400$; left on the refit loan $3100$; April's takings $9000$. Its profit for the year to 30 April was $594$. Fill in the balance sheet's three totals for 30 April, and the year's return on the owner's capital as a percentage.
| Amount | |
|---|---|
| Total assets, dollars | |
| Total liabilities | |
| Owner's interest | |
| Return on the owner's capital, percent |
Lesson test: one question per skill, one attempt each, no hints. Your answers are checked when you submit.
On 30 June, Long Row Gardens has $300$ dollars in cash, is owed $1200$ by customers, holds $400$ of stock at cost and $9000$ of equipment. It owes suppliers $500$ and the bank $5400$. What is the owner's interest, in dollars?
Answer:
You can build a balance sheet, read the owner's interest off it, and work its current and acid-test ratios. Tell someone why buying a van with a loan makes the business bigger and its owner no richer. Next: the cash-flow statement, which explains how the cash on the balance sheet got to be what it is.
16. Your turn: assets of 9600, owed to suppliers 1400, a loan of 3000, step 3
$4400 + 5200 = 9600$
Liabilities plus owner's interest equal the assets.