What is a statement of financial position? – Definition
A Statement of Financial Position is a snapshot in time looking always at past events, i.e. transactions that have already taken place. An accounting period of 12 months is generally used for this type of financial reporting. Users of this type of information include management, owners, employees, lenders, etc.
Statement of Financial Position: an introduction
The first consideration to be given to any new business venture is that of finance. A trading business needs substantial funds or extended credit facilities from the outset. A place has to be found for the storage and safety of merchandise, and thought needs to be given to deliveries (involving transport), communications (post, telephone and email), and the recording of cash and credit dealings (the bookwork and accounts).
In addition, at least some small reserve of finance is required to maintain oneself during the initial period of creating or developing the business. Before we start on the routine book work of a typical small trader, we shall take a glimpse at one of the targets and main end-products of this short course in elementary accounting. This is a financial statement called the Statement of Financial Position (sometimes called the balance sheet).
Suppose your great-aunt Sarah recently died and left you $5000. You decide to be ‘your own boss’ and start a business from your home address.
With effect from 1 June, this $5,000 is allocated to your new business venture to become the sole asset and property of the business in your name. The business, regarded as separate from you personally, acknowledges its debt to you as owner and proprietor in this opening balance sheet, thus:
Statement of Financial Position as at 1 June
|You may have other sources of income and property of your own, but that is your private affair, quite distinct from this new trading venture now being financed by your investment of $5000.|
The routine business dealings of a small retail trader are called transactions. Generally, they involve the purchase and sale of merchandise for cash and/or credit (where payment is delayed), the settlement of trade and expense accounts for goods bought and for services used, and occasionally the purchase of a ‘non-current’ asset (sometimes called a ‘fixed asset’) for permanent use in the business.
During the first week of June, a number of transactions take place, and in this particular instance a separate balance sheet has been drawn up simply to illustrate how this financial statement is affected in two ways by each transaction. Normally, though, the listing and grouping of assets and liabilities on a balance sheet would be made in greater detail at the end of the trading period, perhaps every six months or only once a year.
2 June: You pay $1,300 for storage cupboards and some strong shelving.
NB: The four stages of these elementary balance sheets are explained by simple arithmetic.
Statement of Financial Position as at 2 June
|Property has been acquired for permanent use by the business. This purchase is shown as a ‘non-current’ asset. Cash is decreased by the sum paid out.
The payment for the non-current asset does not affect the holding of the proprietor (his capital) nor current liabilities, as the business at this stage has no outside debts.
3 June: You buy goods on credit priced at $2,000 from Wholesalers Ltd, arranging to pay for the goods bought later in the month.
Statement of Financial Position as at 3 June
|Goods to the value of $2,000 have been taken into the inventory at cost price, increasing current assets to $5,700. These goods have been bought on credit (no money has been paid). So cash remains at $3,700.
There is still no change in the owner’s capital account. However, an outside liability has been incurred by $2,000. The individual names of accounts payable do not appear on the Statement of Financial Position.
4 June: You sell goods priced at $600 to a cash customer, and further goods priced at $400 to a credit customer (to be paid at the end of the month).
Say you make a profit of 20% on the selling price. The cost of the goods sold is thus $800.
Statement of Financial Position as at 4 June
|$800 of inventory (at cost) is sold for $1,000. This leaves inventory balance in hand at $1,200. The cash position is now $3,700 + $600 = $4,300.
Amount due from credit customer ($400) is shown under ‘accounts receivable’.
The difference between the cost price $800 and the selling price of $1,000 is the trading profit. This is added to the proprietor’s capital as the reward for investment.
5 June: You pay $500 off your supplier’s account for the goods bought on 3 June, and then withdraw $250 cash for your own private and personal use.
Statement of Financial Position as at 5 June
|The $500 paid off accounts payable account reduces both the business cash and the amount of the trade liabilities total. The inventory figure is not affected by this payment.
The sum of $250 withdrawn for the proprietor’s own use is called ‘drawings’. Business cash is reduced and also the proprietor’s holding or net assets as shown by his capital account.
Note how the proprietor’s capital account of this small business remains constant until affected by:
- business profits or losses
- withdrawals by the proprietor (and it would of course be increased by additional private capital paid into the business).
Some elementary accounting concepts have been touched upon in this short balance sheet preamble. At each stage, there is the emphasis upon total assets equalling total liabilities (including the capital). The accounting equation A = C + L applies all the way through, where:
A represents the total assets of the business
C the proprietary capital and
L the external debts and liabilities of the business.
Remember that the Statement of Financial Position reflects the accounting equation and there are several ways to write the accounting equation, which means there are several ways to present the balance sheet. You must take this into account and be flexible when you see different financial statements.