A statement of financial position reports a company’s financial position at a point in time. It is also called a balance sheet. The balance sheet reports the company’s resources which are the company’s assets. These are what the company owns. The balance sheet also reports the sources of financing the assets.
There are two ways a company can finance its assets. It can raise money from stockholders; this is called owner financing. It can also raise money from banks or other creditors and suppliers; this is called nonowner financing. This means that both owners and nonowners hold claims on company assets. Owner claims on assets are referred to as equity and non owner claims are referred to as liabilities (or debt).
Since all financing must be invested in something, then investing equals financing. This is called the accounting equation, which follows:
Assets = Liabilities + Equity
For example, a company’s accounting equation is:
Assets = N234,567; Liabilities = N157,065 and Equity = N77,502
Balance sheets are organized like the accounting equation. Investing activities are represented by the company’s assets. These assets are financed by a combination of nonowner financing (liabilities) and owner financing (equity).
Balance sheet categorizes assets into cash and noncash assets. Noncash assets consist of several asset categories. For example, companies own a category of assets called inventories. These are goods that the company intends to sell to its customers. Inventories are converted into cash when they are sold, which typically occurs within a short period of time. Hence, they are classified as short-term assets. Companies also report a category of assets called property, plant and equipment. This category includes a company’s office buildings or manufacturing facilities. Property, plant and equipment assets will be held for an extended period of time and are, therefore, generally classified as long-term assets.
Assets must be paid for, and funding is provided by a combination of owner and nonowner financing. Owner (or equity) financing includes resources contributed to the company by its owners along with any profit retained by the company. Nonowner (liability) financing is borrowed money.
When Statement of Financial Position is Used
This organization of a balance sheet gives investors and creditors a clean and easy view of the company’s resources, debts, and economic position that can be used for financial analysis purposes.
Investors use this information to compare the company’s current performance with past performance to gauge the growth and health of the business. They also compare this information with other companies’ reports to decide where the opportune place is to invest their money.
Creditors, on the other hand, are not typically concerned with comparing companies in the sense of investment decision-making. They are more concerned with the health of a business and the company’s ability to pay its loan payments. Analysing the leverage ratios, debt levels, and overall risk of the company gives creditors a good understanding of the risk involved in loaning a company money. Internal management also uses the financial position statement to track and improve operations over time.
In my next post I will share the next financial statement which is the income statement