5.4 Statement of Financial Position (Balance Sheet)
Why it matters – link to the Cambridge IGCSE Business Studies syllabus
- Business activity: The statement shows how a business’s resources (assets) are financed – either by owners (equity) or by creditors (liabilities). This reflects the firm’s purpose, size and the expectations of stakeholders such as investors, banks and tax authorities.
- People in business: It is prepared by the finance team (often the accountant) and reviewed by senior management. Clear internal communication of the SFP helps managers make decisions about investment, pricing and staffing.
- Marketing: A strong asset base (e.g., modern machinery or attractive premises) can justify a new product launch or a larger advertising budget because the business has the financial capacity to support it.
- Operations management: The type and amount of non‑current assets (machinery, plant, buildings) reveal the production method used (job, batch or flow) and affect depreciation costs, which in turn influence break‑even analysis.
- Financial information and decisions: The SFP is one of the three core financial statements. It works together with the income statement and cash‑flow forecast to help answer questions about:
- Sources & uses of finance
- Liquidity and solvency
- Profitability (via ratios such as ROCE)
- External influences: Tax changes, exchange‑rate movements or new environmental legislation can alter the amounts shown on the SFP (e.g., higher current liabilities for tax payable, re‑valuation of property).
1. The accounting equation
Assets = Liabilities + Equity
This equation must always balance – it is the foundation of the Statement of Financial Position.
2. Classification of items
2.1 Assets
Resources owned or controlled that are expected to bring future economic benefit.
2.1.1 Current assets (realised or used within 12 months)
- Cash and cash equivalents
- Trade receivables
- Inventories
- Pre‑payments
2.1.2 Non‑current assets (held for more than 12 months)
| Asset | How it is recorded | Depreciation? |
|---|
| Land |
Cost price + directly attributable costs (legal fees, surveyors) |
No – land is not depreciated |
| Buildings |
Cost price + legal, stamp duty, site‑preparation costs |
Yes – straight‑line over estimated useful life |
| Machinery / Plant & equipment |
Cost price + delivery, installation and testing costs |
Yes – straight‑line (or other systematic method) over useful life |
| Other examples (not required for IGCSE) |
Vehicles, furniture, patents, computer software |
Depreciated (except patents – amortised) |
2.2 Liabilities
Obligations the business must settle in the future.
2.2.1 Current liabilities (payable within 12 months)
- Trade payables
- Bank overdrafts (short‑term borrowing)
- Accrued expenses (wages, interest, tax payable)
2.2.2 Long‑term liabilities (payable after 12 months)
- Bank loans (repayment over several years)
- Debentures / bonds
2.3 Equity
The owners’ residual interest after all liabilities have been deducted.
- Owner’s / share capital – original investment
- Retained earnings – profit from the income statement that has not been withdrawn
3. Key terminology
- Historical cost – the amount actually paid to acquire the asset (including any directly attributable costs).
- Accumulated depreciation – total depreciation charged to the asset since it was acquired.
- Net book value (NBV) – Cost – Accumulated depreciation. (For land, NBV = cost because no depreciation is charged.)
4. Presentation of the Statement of Financial Position
Assets are listed first, starting with current assets, then non‑current assets.
Liabilities follow, starting with current liabilities, then long‑term liabilities.
Equity is shown last. Non‑current assets are presented at their NBV.
| Statement of Financial Position (as at 31 December 20XX) |
Amount (£) |
| Assets | |
| Current assets | |
| Cash and cash equivalents | | 10,000 |
| Trade receivables | | 8,000 |
| Inventories | | 12,000 |
| Non‑current assets | |
| Land (cost) | | 50,000 |
| Buildings (cost) | | 120,000 |
| Accumulated depreciation – Buildings | | (30,000) |
| Machinery (cost) | | 80,000 |
| Accumulated depreciation – Machinery | | (20,000) |
| Total assets | 210,000 |
| Liabilities | |
| Current liabilities | |
| Trade payables | | 15,000 |
| Bank overdraft | | 5,000 |
| Long‑term liabilities | |
| Bank loan (repayment after 5 years) | | 50,000 |
| Total liabilities | 70,000 |
| Equity | |
| Owner’s capital | | 140,000 |
| Total liabilities and equity | 210,000 |
5. Sources & Uses of Finance – linking the SFP to the syllabus
| Source of finance | Typical example on the SFP | Short‑term vs. long‑term |
|---|
| Owner’s capital / share issue |
Equity – Owner’s capital £140,000 |
Long‑term (permanent) |
| Retained earnings |
Equity – part of Owner’s capital (not shown separately in the example) |
Long‑term (internal) |
| Bank overdraft |
Current liability – Bank overdraft £5,000 |
Short‑term |
| Bank loan |
Long‑term liability – Bank loan £50,000 |
Long‑term |
| Trade credit |
Current liability – Trade payables £15,000 |
Short‑term |
6. Relationship to the Income Statement & Cash‑flow Forecast
- The profit (or loss) shown on the income statement is transferred to the equity section of the SFP as retained earnings. This explains why equity grows when the business is profitable.
- The SFP is a “snapshot” at a single date; it does not show cash movements. A cash‑flow forecast complements it by showing how cash is expected to flow in and out over the next period, helping to assess whether the business can meet its short‑term obligations.
7. Key Ratios – calculation and interpretation (using the example figures)
| Ratio | Formula | Calculation | Interpretation |
|---|
| Current Ratio |
Current assets ÷ Current liabilities |
(10,000 + 8,000 + 12,000) ÷ (15,000 + 5,000) = 1.7 |
>1 indicates the business can meet its short‑term debts; 1.7 is healthy. |
| Debt‑to‑Equity Ratio |
Total liabilities ÷ Equity |
70,000 ÷ 140,000 = 0.5 |
Only ½ £ of debt for every £1 of equity – low financial risk. |
| Return on Capital Employed (ROCE) |
Profit before interest & tax ÷ (Equity + Long‑term debt) |
Assume profit before interest & tax = £30,000 → 30,000 ÷ (140,000 + 50,000) = 13.6 % |
Shows how efficiently the business uses its long‑term financing to generate profit. |
8. A structured 5‑step approach to interpreting the SFP (AO3/AO4)
- Identify the key figures – total current assets, total current liabilities, total non‑current assets, total liabilities, total equity.
- Calculate the relevant ratios (current ratio, debt‑to‑equity, ROCE, asset turnover if required).
- Compare the ratios with:
- the business’s own previous periods
- industry benchmarks (e.g., retailers usually have a high current ratio, manufacturers a higher proportion of machinery).
- Infer the financial health:
- Liquidity – can short‑term debts be paid?
- Solvency – is the firm overly dependent on borrowing?
- Asset composition – what does it tell you about the nature of the business?
- Evaluate the implications for stakeholders:
- Creditors – are they comfortable with the current ratio and debt levels?
- Owners/investors – is the return on capital satisfactory?
- Management – does the asset mix support the strategic plan (e.g., expansion, new product launch)?
9. External Influences on the Statement of Financial Position
| External factor | Possible effect on the SFP |
|---|
| Tax legislation (e.g., higher corporation tax) |
Increase in current liabilities (tax payable) and reduction of retained earnings. |
| Exchange‑rate fluctuation (import‑dependent business) |
Higher cost of imported machinery → increase in non‑current assets (cost) and possibly higher depreciation. |
| Environmental regulations (e.g., required upgrades to plant) |
Capital expenditure on new equipment – increase in non‑current assets and future depreciation expense. |
| Economic recession |
Potential rise in current liabilities (short‑term borrowing) and fall in retained earnings due to lower profit. |
10. Key Points to Remember
- Assets = Liabilities + Equity – the statement must always balance.
- Current items are those expected to be realised or settled within one year; non‑current items last longer.
- Non‑current assets are recorded at historical cost; land is not depreciated, buildings and machinery are depreciated (usually straight‑line).
- Net book value = Cost – Accumulated depreciation (except for land).
- The SFP is a snapshot; it works with the income statement (profit flows to equity) and cash‑flow forecast (shows liquidity over time).
- Use ratios (current ratio, debt‑to‑equity, ROCE) to analyse liquidity, solvency and profitability.
- Interpretation should follow the 5‑step approach and consider the interests of all stakeholders.
- External factors such as tax, exchange rates or legislation can change the amounts shown on the statement.