Statement of Financial position (balance sheet)

Statement of Financial position (balance sheet)

reports on the assets, liabilities or equity of an entity at a specific point in time

• reflects (investing decisions) and how the entity has financed the asses (financing decision)

investing decisions

what the business owns, how much of it (assets)

financing decisions

debt financing, equity financing or mixed? (assets)

stment of financial position tells you:

1. operational structure → investing decision → types + quantity of assets

2. financing : capital structure + risk → debt-to equity

where in balance sheet = How Entity Operates?

INVESTING DECISIONS

• Assets → type : Cash, Inventory, Equipment (PPE), Intangibles

• Quantity → cash heavy? capital-intensive? service-based?

where in balance sheet = entity financing?

• equity vs liabilities

  • debt-to-equity ratio

• high ration → more risk, but more leverage (potential rewards)

where in balance sheet = liquidity risks?

Type of Liabilities

• Look at current vs non-current liabilities:

  • current: (creditors, overdrafts)?

  • non-current (loans, leases)?

⭐ Relevance:

• Short-term debt = pressure on liquidity.

• Long-term debt = more flexibility, but higher interest costs.

where in the balance sheet = financially independence/self sustaining?

Equity financing

• Two main sources:

  • Contributed capital (shareholder investment)

  • Retained earnings (profits kept in the business)

Tells you:

• Entity is self-sustaining or reliant on capital raises (investments)

where in the balance sheet = solvency?

→ can pay off long term debts?

→ have enough assets & equity to do so?

👉 Use this ratio:

Assets > Liabilities → Solvent, Equity positive → healthy

• Equity is positive → Solvent → healthy 👍

• Assets > Liabilities → good 👍

e.g : use debt ratio!

duality

Describes how every business transaction has at least two effects on the accounting equation