In business, the balances of the Cash Account and the Capital Account can be carried down in order to commence the new accounts for the next period. There will be a Purchases Account and a Sales Account for the next trading period, but they will be new accounts without any starting balance from the last period. Continue reading to understand why it is important to maintain an accurate balance sheet for a business.
The balance of the Cash Account brought down represents the amount of cash in hand at the date of balancing the account and available for subsequent trading. The balance of the Capital Account is carried down as it indicates the amount to the owner’s credit at the date of balancing and at the beginning of the new trading period.
From the point of view of the business the cash balance in hand represents a valuable possession, whereas the balance of the Capital Account is the amount for which the owner has a residual claim against the business. In short, the cash is an asset and the balance of the Capital Account is a claim against the business.
The term ‘asset’ is applied to all forms of property and possessions which the business holds, including all debts due to the business and the term ‘claim’ to all sums owing by the business. When claims are due to third parties (e.g. trade creditors or lenders) they are called liabilities. Liabilities can be the owner’s capital or the liabilities to parties outside the business.
If a business owner wishes to know the financial position of the business at the date of balancing the accounts, all that is necessary is to trace the assets and claims and to set them down in customary form. The statement is called the Balance Sheet and comprises the balances of all of the accounts in the Ledger after the appropriate transfers have been made in the preparation of the Trading and Profit and Loss Accounts. All such remaining balances are either assets or claims and the statement is compiled by placing the claims on the left-hand side and the assets on the right-hand side.
This is the simplest form a Balance Sheet can take, but it illustrates the principles underlying its compilation. The Balance Sheet is not a Ledger account; it is a summary listing the outstanding balances. It is equally valuable as a statement of the financial position in the sides is reversed, but it conforms to the traditional practice in England to have the claims on the left-hand side and the assets on the right. In some countries, including the U.S.A., these listings are reversed, i.e. the assets are on the left and the claims on the right.
Many balance sheets now list the claims and assets vertically one under the other. A comparison of the two Balance Sheets shows that one of the results of trading has been an increase in the value of the business assets but, at the same time, the amount claimed against the business, in this case by the proprietor, has been increased by a similar sum.
In the end, the two sides of the Balance Sheet must agree in total. The fact that they should do so provides a further arithmetical check on the accuracy of the entries in the accounts and on the preparation of the Trading and Profit and Loss Accounts.
The equality of the two sides of the balance sheet is derived from the equality of sources and uses of funds. The assets side lists the past uses made of funds, insofar as they still affect the future at the time of preparing the Balance Sheet. The claims side shows the sources of past funds, which still hold a claim against the business that will have to be settled at some time in the future. These two totals must be equal. The balancing figure is the profit or loss. The balance sheet can thus be represented by the following equation:
ASSETS = CLAIMS [where CLAIMS = (OWNER’S CAPITAL + PROFITS) + LIABILITIES]
