Debt and Equity
The liability side of the Balance Sheet can be broken down into more categories.
A company can owe funds to debt holders or equity holders.
• Debt holders represent those who do not own the company, but are owed by the company for previous transactions. Examples above are Payables and Bank Loans.
• Equity Holders represent the owners of the company who have invested money into the company in return for shares (shares are often referred to as equity). This is shown in the example, where the share capital and retained earnings are listed. Share Capital is the value of shares purchased in the company and retained earnings are profits made by the company; both of these are the property of the owners of the company.
Current Assets
Current Assets relate to assets which are highly liquid and easily realised. Looking at the items on the balance sheet, there is a large balance of cash in the bank. This is highly liquid and easily realised, as T Bone could withdraw and use this asset very quickly. Likewise, receivables are customer balances that T Bone is expecting to be paid in the near future. Stock is also likely to be sold soon, so it is classified as a current asset. As a general rule, we expect current assets to be realisable within 12 months.
Current Liabilities
These are debts that are payable within twelve months, hence, a short term loan, trade payables and accruals are included.
A trade payable arises from a supplier giving T Bone a period to pay an invoice; typical trade terms are 30 days but this can vary,.
Fixed Assets
These are assets which are being used by the business in the longer term. Therefore, we expect all the items listed to be in use within the business at least twelve months later.
Machinery and/or a building would constitute fixed assets as we would expect to own these items in the long run and use the investment in them to trade on an ongoing basis.
Working Capital
Working Capital relates to Current Assets and Current Liabilities, usually compared in a ratio.
Example:-
TBone has 135000:208000, therefore a ratio of 1.35: 2.08.
This calculation is very important, as the Working Capital position shows how the business can defend itself in the immediate future from any unexpected change.
This shows the short term obligations which will need to be met, as opposed to the liquid resources which could be utilised, in a time of stress.
Discussion Point
Why was this so important during the Credit Crunch?
What would be a concern for any consultant reviewing T Bone’s financial health?
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