Statement of Financial Position is a primary financial statement which gives the financial position of business on the date when this statement is prepared. The previous name for this statement was “Balance Sheet” and most of the businesses still use this title for this statement. Just like Statement of Profit or Loss, this statement is presented mostly for the whole group and could be called as “Group Balance Sheet” or “Consolidated Balance Sheet.” Statement of Financial Position would also give data for at least two years so you will see two columns for the data here. However, in some cases, there will be data for both parent company and for the whole group with four columns on this statement.
Above the columns you would see the date on which Statement of Financial Position was prepared famously known as “the Balance Sheet date.” This is the date when accounting period ends, process of finalizing the financial reports for the period starts and most of the data given on annual reports relates to. However, annual reports may contain information relating to post Balance Sheet date events, if those events are significant enough, as it takes long time to prepare the annual reports(3-6 months).
The Statement of Financial Position gives data and figures for three elements of financial statements which are
1.Assets,
2.Liabilities and
3.Capital or Equity.
There are usually five sections on Statement of Financial Position with sub-totals given for each category as
•Non-current Assets
•Current Assets
•Current Liabilities
•Non-current Liabilities
•Equity
For some ratios these sub-totals are needed, for example current ratio, while for others, e.g., Return on Capital Employed, we would need to extract an individual figure given on this statement or in the related notes to the accounts.
We will locate and discuss all the relevant figures while carrying out ratio analysis.
Unlike Statement of Profit or Loss which gives totals for revenues and Expenses for the whole year, Statement of Financial Position gives static data on the balance sheet date e.g. the value of assts on that date which can change next day.
This statement presents a basic but an important concept of accounting called “the accounting equation.” As per the accounting equation
Assets = Capital + Liabilities
This means that if we carryout accounting processes properly, the value of total assets will always be equal to the sum of the values of capital and liabilities. This is the reason a Statement of Financial Position would always be balanced, the source of the name “Balance Sheet.”
The presentation of this statement is often given as per the accounting equation giving the value of total assets and then second part of the statement would give total for liabilities and equity. However, the accounting equation can also be written as
Capital (Equity) = Assets – Liabilities
Hence this statement can also be found in this format for many companies. Actually, in some cases, this structure is more helpful as the book value of the business is available in one figure called “Net Assets.” Net assets can be calculated as
Net Assets = Assets – Liabilities
and therefore,
Net Assets = Equity
This is worth emphasizing that the value of net assets given on the Statement of Financial Position is only the book value of the business. In most cases, the actual (market) value of the business is different than the Net Assets figure in the books (Financial Statements). A business which is performing well has a much higher market value also known as “market capitalization (Cap)”. For example, Net Assets of Burberry Plc are £1.2b as per their 2020 annual reports while the market cap on that day was £5.4b. It is also possible for a struggling business to have a market value which is less than Net Assets figure given in the Statement of Financial Position, however, as soon as this is known, a reduction in the value of assets should be recognized, following the rules on impairment of assets, bringing the values equal or less than market cap. For example, COVID-19 has caused a reduction in the values of many businesses’ assets in the hotel and tourism industry. This reduction is known as “impairment” of assets which means the asset has lost its value and it is now being reflected in the financial statements. This impairment has caused a significant increase in the operating costs of the businesses, however, costs like these are given as “exceptional item” (or in similar wording) separately in Profit or Loss Statement. It is important to make a note of such costs in your analysis and use this information to explain the significant increases in costs and reduction in profit figures. Therefore, it is important to consider the latest data while carrying out financial analysis. This data is available on news, companies’ websites etc.
The book value of the assets is different than the market value for another reason and that is internally generated “Intangible Assets” like brands and Goodwill which are not recorded on the balance sheet. For companies like Tesla, the total value of the company is often a lot more than the book value of their assets due to innovative processes and patents they own.
This article is written by Raja Mizan who is a senior lecturer in accounting & finance in a UK university. He is an ACCA member and also runs his own accountancy practice RMR Accountants & Business Advisors.