Statement of Financial Position

Statement of Financial Position

• A Statement of Financial Position, also known as a Balance Sheet, is a financial document that presents an organisation’s financial status at a particular point in time.
• It consists of three main components: assets, liabilities, and equity.
• Assets are resources owned by a business that can be measured in financial terms. These are further divided into current assets (expected to be converted to cash within one year, e.g. inventory) and non-current assets (long-term resources like property and machinery).
• Liabilities refer to what the business owes to outsiders or obligations it needs to fulfill. Like assets, these can be current liabilities (due within one year, e.g. short-term loans) or non-current liabilities (due after one year, such as mortgages).
• Equity represents the owners’ interest in the business. It is computed as the difference between assets and liabilities, and includes share capital and retained earnings.

Purpose of a Statement of Financial Position

• The main purpose of a Statement of Financial Position is to provide a snapshot of a company’s financial health.
• It can be used by various stakeholders such as shareholders, creditors, and potential investors to assess the financial stability and growth potential of a business.
• The statement is also crucial for business owners and managers for making informed decisions, planning, and controlling business operations.

Analysing a Statement of Financial Position

• The liquidity ratio (current assets / current liabilities) can be calculated from a Statement of Financial Position. A ratio greater than 1 implies sufficient assets to cover short-term liabilities, desirable for financial stability.
• The gearing ratio (non-current liabilities / total equity) x 100% measures the proportion of a company’s capital that comes from debt, and indicates financial risk. High gearing suggests a company is heavily reliant on borrowing.
• Changes in assets, liabilities, and equity over time can indicate positive or negative trends in a company’s financial position.

Limitations of a Statement of Financial Position

• As only a snapshot, the Statement may not reflect current market conditions or imminent changes.
• Some valuable resources like business reputation and employee skills aren’t quantifiable and hence aren’t included.
• It might not factor in true cost of assets if they’ve depreciated since purchase.
• It doesn’t show how effectively assets are being used to generate profit. Other documents like the income statement provide a more comprehensive view.