The Balance Sheet (AQA A Level Business): Revision Note

An introduction to the balance sheet

• The balance sheet provides a snapshot of a business’s financial position at a given point in time. It shows what the business owns (assets), what it owes (liabilities), and how it is funded (capital and reserves)

• It contains the financial information required to draw conclusions about the liquidity of the business

Stakeholder interest in the balance sheet

The structure of the balance sheet

• The balance sheet details the following elements at a specific point in time

An example balance sheet showing key elements

• In this example, drawings refers to the Money (capital) removed from the business by its owner(s)

Analysing the balance sheet

• By analysing key elements of the balance sheet, businesses and stakeholders can assess:

1. Working capital situation

• Working capital shows whether a company can meet its short-term financial obligations and is calculated using the formula:

Working Capital = Current Assets – Current Liabilities

• Positive working capital (more current assets than current liabilities) suggests the business can cover short-term bills from its short-term assets

• Negative working capital can indicate cash-efficient operations (e.g. getting paid by customers before paying suppliers) but may also risk liquidity problems

  • E.g. Tesco plc often has low working capital because it turns over stock quickly and negotiates extended payment terms with suppliers, effectively using supplier credit to fund day-to-day operations

2. Level of non-current assets

• A high proportion of non-current assets to total assets indicates a capital-intensive business, common in primary and secondary sector businesses

  • It can can offer competitive advantage (e.g. efficient factories), but ties up capital and risks obsolescence

• A low proportion suggests a business owns few non-current assets, common in service or software businesses

  • This reduces depreciation costs but may limit capacity or scalability

3. Gearing

• High gearing (more debt than equity) can boost profits when things go well but risks bankruptcy if income drops

• Low gearing (less debt) makes the business safer but can slow growth because issuing new shares or equity can be costly

4. Level of reserves

• Strong reserves enable a business to pay dividends, fund projects without the need to borrow and absorb unexpected losses

  • They also signal consistent profitability and good financial management

• Low or negative reserves limit dividend payments and may force the business to seek external finance such as loans

  • Depleting reserves can indicate poor business performance and recurring losses

Window dressing

• Window dressing is the use of short-term techniques to make a firm’s financial statements look stronger than they really are, even though the underlying performance hasn’t changed

Common window dressing techniques