The Statement of Financial Position, also called Balance Sheet, is a financial statement that gives a detailed information about the financial position of an entity at a specific point in time.
The Statement of Financial Position or Balance Sheet, is one of the financial statements that businesses prepare for their stakeholders. It is usually compared to a photograph or a snapshot of your company’s financial position, i.e. where your company financially stands at a given point in time.
Financial Position refers to the status of your company’s assets, liabilities and equity, and their relationship with each other. The financial position of your company is usually affected by its economic resources, financial structure, liquidity, and solvency.
Below is an example of a statement of financial position.
Assets are the economic resources of your company used to produce a product or service and generate revenues. The way your company increases and utilizes its resources over time is a good indicator of its ability to generate additional resources in the future.
An increase in the company’s resources may be a sign of improving financial position while a decrease could be an indicator of mismanagement of resources. Analyzing how a company manages its economic resources is very helpful to those investors who are looking into investing their money in the company.
To acquire assets without using any profits from your company, you have two options: via equity financing and via debt financing. Thus, the financial structure of your company will always be a mixture of debt and equity instruments.
A healthy mix of debt and equity financing can help your company achieve its goals efficiently. Having a higher amount of liabilities than equity is a red flag and may indicate that the company relies too much on debt financing and is unable to produce enough profits to sustain its operations.
Analyzing the financial structure of a company is useful when predicting how future profits and resources will be distributed among its creditors and owners. It is also useful in determining the future financing needs of the company and its ability to raise them.
Liquidity is the ability of your company to convert its current assets into cash to pay for short-term liabilities. Solvency, on the other hand, is the ability of your company to pay for its long-term financial obligations as they fall due.
When the amount of liabilities are disproportionately higher than the assets, it may indicate the company’s inability to pay its debts. And if a company has a reputation of not being able to pay its debts on time, it could have a hard time borrowing funds and entering into a credit agreement with a potential supplier. In worst case scenarios, the inability to pay may lead to involuntary bankruptcy of the company.
An Asset is a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits.
Assets are usually the first items that you’ll see in a statement of financial position.
For your company to achieve its goals and earn profits, it needs assets that it could use for its operations. Some examples of these assets are cash, merchandise inventories, computers, vehicles, office buildings, factories, patents, trademarks, computer software, franchise, and financial assets such as stocks and bonds.
Assets can be in the form of physical properties such as land and building, items of value such as financial assets, and rights that are owned and controlled by the business such as intangible assets. They are used up immediately or over a period of time in your business operations to generate profits.
When a company is just starting out, its first assets usually come from investments made by the owner or its founder. As the business grows and additional assets are needed, the company may acquire assets using financing coming from investors and creditors.
Based on the definition above, the following are the characteristics of an asset:
Some examples of a right that has the potential to produce economic benefits are as follows:
The potential to produce economic benefits does not need to be certain, or even likely, that the right will produce economic benefits. It is only necessary that the right already exists.
An economic benefit is a benefit that can be quantified and expressed in terms of money that it generates. It can be in the form of income or cost savings.
A company has control over the economic resource if it has a present ability to direct the use of an economic resource and obtain the economic benefits that may flow from it. Having control means management can freely employ or dispose the asset. In addition, any future economic benefit that may be produced by the asset must flow only to the company instead of another entity.
A transaction or event that occurred in the past gave the company control over the economic resource. An expectation of transaction or event to occur in the future won’t by itself give rise to any asset. To be considered an asset, the economic resource must exist now as opposed to being created or delivered in the future.
The most common way to obtain an asset is by purchasing or producing them. However, a company can also receive an asset by way of a government grant designed to provide an economic benefit or to encourage economic growth.
Assets can be classified as either Current Assets or Noncurrent Assets.
Current assets are assets that are expected to be sold, consumed, or converted into cash within twelve months or the normal operating cycle, whichever is longer. This includes assets held for trading purposes and unrestricted cash and cash equivalents.
The International Accounting Standards (IAS 1) sets out the requisites of a current asset as follows:
When presenting current assets in your company’s statement of financial position, they are usually the first ones to be shown in the assets section. However, other forms of presentation are available such as presenting noncurrent assets first before the current ones. Furthermore, businesses can also present assets by increasing or decreasing order of liquidity rather than categorizing them as current or noncurrent.
Current assets are liquid assets that your company controls that include any of the following:
Below are some examples of current assets.
Cash and Cash Equivalents are the most liquid assets that every company has. They generally include the following:
The term Cash refers to:
The Cash account in the statement of financial position includes the following:
Some investments can be considered cash equivalents and presented together with cash in the statement of financial position. Examples of cash equivalents are commercial papers, government treasury bonds, preference shares with specified redemption date, money market funds, and time deposits that meet any of the following criteria:
Short-term Investments are highly-traded financial assets such as stocks and bonds that a company purchases with the intention to sell in the short term to make a profit from price increases. These investments are actively traded in financial markets. Also included in short-term investments are time deposits, treasury bills, money market instruments, and commercial papers that have maturity terms of more than three months but within one year.
If your company has excess or idle cash sitting around, you can invest them in short-term investments with the intention of earning a higher amount compared to the interests that a demand deposit account offers.
Receivables are amounts owed by customers to your company for the goods, services or credit that they have received but not yet paid. Receivables can be classified as Trade Receivables and Nontrade Receivables.
Trade Receivables are amounts that are receivable from your customers for goods or services delivered to them in the ordinary course of your business operations. They are typically evidenced by sales invoices that are issued to customers when goods are shipped or services are performed.
Trade receivables are usually recorded in an Accounts Receivable account which is classified as a current asset since they are expected to be realized or converted into cash within the entity’s normal operating cycle or one year after the reporting period, whichever is longer.
Nontrade Receivables, on the other hand, are amounts owed to your business other than the sale of goods and services on account. They are typically receivables from other activities that are not considered part of the normal operating activities of your business. Examples of nontrade receivables are Interest Receivables, Advances to Employees, Dividends Receivable, and Notes Receivable.
Nontrade Receivables are classified as current assets if they are expected to be paid within one year, regardless of the length of the entity’s normal operating cycle. If payment is to be made for a period longer than a year, nontrade receivables are classified as noncurrent assets.
The type of inventories you may have would depend on the legal form of your company. If you’re a manufacturer, your inventory accounts would include the following:
On the other hand, the inventory account you’ll only use as a merchandiser is the Merchandise Inventory account which represents the stock of finished goods that are available for sale by your business. Service-based businesses generally don’t carry any inventory that is for sale to their customers.
Prepaid Expenses, also called Prepayments, are advance payments that can be made by your company for certain expenses or services that it will receive in the future. These expenditures are usually paid in full in one accounting period but the benefits from which will apply in future accounting periods.
A prepaid expense is considered an asset due to its nature as an expense that was already paid in advance but not yet incurred. As a result, your company does not have to pay for it anymore in the future. Examples of prepaid expenses are Prepaid Insurance, Prepaid Supplies, and Prepaid Rent.
Since prepaid expenses are usually consumed within a year or less, they are initially recognized as a current asset in the statement of financial position. When the asset is actually used or consumed afterwards, the cost is eventually charged as an expense and reflected in the income statement.
Noncurrent Assets are assets that are not easily realized or converted into cash within twelve months after the reporting period or within the normal operating cycle.
As defined by IAS 1, all other assets not classified as current assets shall be classified as noncurrent assets. These assets last for more than one accounting period and are not liquid, which means that converting them into cash or using them could take a longer time.
Let’s have a brief overview of some of the noncurrent assets below.
Property, Plant and Equipment (PP&E), also called Fixed Assets or Capital Assets, are physical assets that could support your operations and has the potential to produce economic benefits for your business over a long period of time, i.e. more than one year. These tangible assets are generally used in the production or supply of goods and services, for rental, or for administrative purposes.
Fixed Assets are illiquid and are not intended to be sold like merchandise inventories in a normal course of business operations. They are part of the production base of a business especially in capital-intensive industries such as manufacturing where a large portion of the company’s assets are fixed assets.
Some examples of PP&E are as follows:
Long-Term Investments include investments that can be held by your company without any intention of being sold within one year after the reporting period. These investments include ownership shares of another company, bonds issued by another company, money market instruments, promissory notes, and treasury bonds with a maturity term of more than one year.
Land or building that are held to earn rentals or for capital appreciation are called Investment Properties and are also treated as long-term investments. Bond Sinking Funds which are used for the retirement of long-term bond liabilities issued by a company are classified as long-term investments.
Intangible Assets are identifiable non-monetary assets without physical substance that can be controlled by your company as a result of past events and which has the potential to produce economic benefits are for the business. Examples of intangible assets are patents, trademarks, goodwill, copyrights, and franchise.
Noncurrent assets that are not included in the above categories are classified as Other Noncurrent Assets. An example of this is the portion of a prepaid expense that is unlikely to be consumed within twelve months after the reporting period. Another example are advances to officers and employees that can be collected beyond twelve months after the reporting period.
A Liability is a present obligation of the entity to transfer an economic resource as a result of past events.
Liabilities are usually presented next to assets in the statement of financial position.
Liabilities are economic obligations of a company owed to creditors or outside parties for assets or services acquired in a past event with the promise to pay in the future. They represent the portion of the company’s assets provided and claimable by creditors.
For a liability to exist, three criteria must all be satisfied:
Let’s briefly explain each requirement below.
An obligation is a duty or responsibility that your company has no practical ability to avoid. It is always owed to another party which could be a person, another entity, a group of people or other entities, or society at large.
Obligations arise from normal business practices, from binding contracts or from statutory requirements.
An obligation should have the potential to require your company to transfer an economic resource to another party to pay for it. Some ways to transfer economic resources as settlement of a present obligation of your company can be as follows:
The present obligation of your company exists as a result of a past transaction or event where economic benefits were already received by your business. As a consequence, your business has to transfer an economic resource that it would not otherwise have had to transfer.
The obligation must be present and existing for it to qualify as a liability. For this reason, you should not recognize a liability in anticipation of a future obligation. For example, a plan to acquire assets in the future does not give rise to a present obligation.
Liabilities can also be classified as either Current Liabilities or Noncurrent Liabilities.
Current liabilities are obligations that are expected to be settled within one year or the normal operating cycle, whichever is longer. This includes liabilities that are held for trading purposes and those that are due to be settled within twelve months after the reporting period, and for which the entity does not have an unconditional right to defer settlement for at least twelve months.
IAS 1 sets out the requisites of a current liability as follows:
Current liabilities usually appear first in the liabilities section of the statement of financial position. However, your company can also opt to present liabilities in another way for as long as such presentation provides information that is reliable and more relevant. For example, if your company is a financial institution, it can present liabilities with increasing or decreasing order of liquidity.
Below are some common examples of current liabilities.
Accounts Payable is a liability that is owed by your company to trade creditors or suppliers for the purchase of goods or services that have already been received by your business in the ordinary course of its operations. It is usually supported by a sales invoice that is issued by your supplier.
Accounts payable are considered current liabilities because it is expected to be settled within twelve months after the reporting period or within your company’s normal operating cycle, whichever is longer.
Notes Payable is a current liability that is supported by a promissory note which is due within twelve months after the reporting period. A promissory note is a written contract in which the maker or debtor promises to pay the creditor or payee a definite sum of money in the future. It can either be an interest bearing note or a non-interest bearing note.
In some cases, your company may issue a promissory note to replace any accounts payable the business has if an extension in payment terms is needed.
Loans Payable is an amount that your company may owe to a bank or a financial institution for money borrowed under a loan arrangement. It can also be supported by a promissory note. The loan amount is subject to accrued interests that are paid until the principal amount is fully settled. Loans that are due within twelve months after the reporting period are classified as current liabilities.
A Warranty Liability is an example of an estimated liability where your company makes an estimate of the amount of repair or replacement costs that it expects to incur for any defective products sold that are still under their warranty period. The warranty liability is recorded at the time of the sale or delivery of the product to the customer.
The estimated amount is usually based on past experiences of the company in providing repairs or replacements of defective products during the warranty period.
Unearned Revenues or Deferred Revenues are obligations that arise when your company receives cash from a customer as an advance payment for goods or services that it still has to deliver in the future. In essence, unearned revenue is income that is already received in the current period but will be earned in a future period when your company delivers the product or service to your customer.
An example of unearned revenue is when a company that rents out office spaces receives advance rental payments from its tenants at the beginning of the year to cover a one-year rental period. As each month passes, the company determines the earned portion of the advance rental payments and recognizes rental income corresponding to the earned portion.
Another example is when a media company receives a one-year magazine subscription fee in advance to cover the issuance of digital magazines to customers for a twelve-month period. The company recognizes subscription revenue for each of the twelve months as it delivers the magazines monthly.
Accrued Expenses are expenses that are already incurred but not yet paid by your business. When your company buys a product or a service, it is expected to pay for its cost. Sometimes, the payment will be made on a future date even if your company has already received the benefits of the product or service that it purchased in the present. A liability is then recognized to account for the accrued expenses that is yet to be paid in the future.
Accrued expenses are typically paid within one year after the reporting period that is why it is generally classified as a current liability. Examples of accrued expenses include interest expenses, utilities, payroll, and taxes that can be accrued in anticipation of future payments.
Accrued Interest Payable is usually recorded when an interest accrues at the end of an accounting period on the money that your company borrowed. This accrued interest is usually paid at the beginning of the next reporting period.
Utilities Payable is the amount due to utility companies for providing electricity, gas, and water services to your business. An accrued liability is recognized for the unpaid amount of utility bills at the end of the reporting period.
Payroll Liabilities or Salaries Payable are recorded for the amounts to be paid to employees or workers for the services that your company receives from them during the payroll period where payment of which will still be made on the next period or payment cycle.
Tax Payable is a current obligation of your company to the government where payment is anticipated on the next accounting period.
The examples above are just some of the common current liabilities that you can see in a statement of financial position. Other liabilities are also recognized as current liabilities if they are expected to be paid within twelve months after the reporting period or within your company’s normal operating cycle.
If your company has a long-term liability that is due to be paid within one year after the reporting period, the liability will be reported as a current liability. Also considered as a current liability is the portion of a long-term debt that is payable within twelve months after the reporting period.
Noncurrent Liabilities are long-term obligations that are expected to be settled beyond one year and may exist for several accounting periods.
According to IAS 1, all other liabilities not classified as current liabilities are to be classified as noncurrent liabilities.
Below are some examples of non-current liabilities:
Any promissory notes or loans your company owes that are payable for more than one year after the reporting period is classified as noncurrent liabilities. However, the portion of the notes payable or loans payable that is payable within one year after the reporting period will be reported as a current liability.
Mortgage Payable is a long-term obligation that is secured by the real properties of your business. Mortgages are used to finance the purchase of large real estate properties without the need to pay the full purchase price up front using any available funds of your business.
In a mortgage agreement, real properties such as land and building serve as collateral to protect the bank or any lender against the borrower’s default. In case of default, the borrower losses the property in foreclosure proceedings that are favorable to the lender.
Bonds Payable are liabilities owed by the bond issuer to the investor or bondholder. They are typically long-term liabilities with maturity dates beyond one year and are classified as noncurrent liabilities.
A bond is a fixed income debt instrument containing a formal promise made under seal by the bond issuer (borrower) to pay the bondholder (lender) a specified sum of money at a determinable future date with periodic interest payments until the principal amount is paid. Governments and corporations issue bonds to raise money to finance projects, operations and capital assets.
Any other debts and obligations your company may have that are not mentioned above and that are payable in more than twelve months after the reporting period are classified as noncurrent liabilities. This also includes the portion of unearned or deferred revenues that are realizable in more than a year.
Always remember that any portion of a noncurrent liability that is due within twelve months after the reporting period is reported as a current liability. However, if your company has a long-term debt that is expected to be refinanced and your company has the discretion to do so, the debt is classified as noncurrent, even if the liability would otherwise be due within twelve months after the reporting period.
