Understanding Accounts is a "finance for non-financial" multimedia CD-ROM to help you read and understand an Annual Report and Accounts, including the Balance Sheet, Income Statement / Profit and Loss Account and Cash Flow Statement.  It also explains the concepts of Assets and Liabilities, Liquidity, Depreciation, Equity and Loan Capital and Gearing, and shows how to use Accounting Ratios to identify trends in a company's financial performance.

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About the Balance Sheet

The balance sheet can be a mystery when it comes to understanding company annual accounts.  How does a balance sheet balance?  Why do we need a balance sheet, when a profit and loss account shows quite clearly whether a business has made a profit and whether that profit was more or less than last year – and most people can understand it?

The layout of the modern balance sheet can add to the confusion.  The original format, with assets on one side, balanced by liabilities on the other, does make sense visually.  But in company annual accounts, the balance sheet now normally appears in a vertical format, which is not nearly so intuitive.

For that reason, Understanding Accounts takes you step by step through the balance sheets of two imaginary businesses.  We start by showing you how the assets and liabilities would look in the old-style side-by-side format, and then show how this converts into a vertical balance sheet.

You also do a variety of interactive exercises, including one where you get to make a balance sheet balance.

Questions and Answers about the Balance Sheet

Why does a Balance Sheet balance?

It can’t do anything but balance.  It’s just a picture of the same pot of money from two different angles.  Where the money came from and how it is being used in the business.

Why do we need a Balance Sheet?

For a start, the Profit & Loss Account only shows part of the picture.  The P&L may show an excellent profit, but, at the same time, has the company burdened itself with debt?  Will the company be able to service that debt or is it becoming over-borrowed?  How solvent is the business? How liquid are its assets? You need the Balance Sheet to see what’s really going on.  Bank managers and other lenders like to see a strong balance sheet, which suggests the business is a good risk.

Why is it sometimes described as a “snapshot” of the business?

Unlike a Profit and Loss Account, which shows how money has flowed through the business over a period of one or more years, the Balance Sheet records the arrangement of the money in a business at one moment in time – just like a still photo.  For that reason, you get a better picture of a company by comparing the balance sheets from different years.

What is meant by “off the balance sheet”?

This means borrowing in such a way that the increased debt does not show on the balance sheet.  Vehicle leasing for example, where the business never actually owns the car or truck, means the capital cost of the vehicle does not appear as a liability in the balance sheet, which it would do if the money had been borrowed as a bank loan.  The rentals to the leasing company just appear as an outgoing in the P&L.  People who can read a set of accounts, will tend to read the P& L and balance sheet together, so they can spot financial manoeuvres like this.

Do Balance Sheets appear in annual accounts in other countries?

Yes, but there are variations.  In the UK, the vertical format balance sheet typically shows two years figures, with a single column for each year.  In the US, they tend to split each year into two or three columns, with sub-totals for Assets, Liabilities and Equity (they may call it “capital”) in the right hand column; in some ways this makes it easier to see how the balance is arrived at.  In the EU, Russia, Australia and elsewhere there is a move toward IFRS (International Financial Reporting Standards).  This can produce balance sheet with the items in a slightly different order, with the Capital or Equity shown at the top of the Liabilities, rather than at the bottom to balance out Total Assets with Total Liabilities. Also some of the terms that appear in the balance sheet and profit and loss account are changing: debtors and creditors, for example, will appear as receivables and payables.  The move to IFRS has also highlighted how there were differences in the way certain figures for the balance sheet were calculated in different countries.  The overall concept is the same – you just have to be sure you are comparing like with like – which is the whole purpose of IFRS. 

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