Guidelines for a proper balance sheet, clearly explained

Every small business owner is obliged to keep accounts and should be familiar with the UK Generally Accepted Ac­count­ing Prin­ciples. These rules ensure that a company’s ac­count­ing system meets all legal re­quire­ments. The UK Generally Accepted Ac­count­ing Prin­ciples are an important part of this. A major aspect of business ac­count­ing is preparing the com­mer­cial balance sheet, which – for example, at the end of a financial year – presents the company’s financial position correctly and clearly. Here, you can find out what this means in concrete terms, what prin­ciples exist, and what else needs to be observed.

Ac­count­ing best practice in the UK stip­u­lates that the annual financial state­ments for a business must be prepared after each financial year for a specific date. Whilst there is no legal standard for ac­count­ing in the UK, all of your book­keep­ing must be able to satisfy the re­quire­ments of the HMRC, Companies House and a variety of other financial reg­u­lat­ors (more in­form­a­tion about which can be found here, as well as  your local au­thor­it­ies when it comes time to pay your taxes. This aside, it is also worth adhering to clear, trans­par­ent, and con­sist­ently struc­tured ac­count­ing methods so that you can access in­form­a­tion ac­cur­ately and easily when necessary.

The prin­ciples of GAAP are as follows:

• Going concern: The accounts must be prepared on the as­sump­tion that the business will continue to trade in the future and therefore a going concern.
• His­tor­ic­al cost con­ven­tion: Companies must account for and report the ac­quis­i­tion costs of assets and li­ab­il­it­ies rather than their fair market value.
• Accruals Concept: All income and expenses for the period to which the accounts relate must be included in those accounts. Pre­pay­ments, accruals, cap­it­al­iz­a­tion of long term assets are examples of accruals concept being applied.
• Prudence: Accounts should be prepared prudently. This means only profits that have been realized should be included in the profit and loss account. In other words, sales should not be re­cog­nized in the profit and loss account until the goods or services have been supplied and normally the invoice raised.
• Netting off: Items should not be netted off in the accounts.
• Con­sist­ency: The directors must select suitable ac­count­ing policies for de­pre­ci­ation of business assets, foreign exchange trans­la­tion and ac­count­ing for stock valuation and applied them con­sist­ently within the same accounts so as to make the accounts easy to read and com­par­able from year to year

These terms and more can be found in our guide to the prin­ciples of proper ac­count­ing.

Here are some guideline rules to keep in mind when preparing a balance sheet:

• A clear balance sheet: A balance sheet needs to be both clear and concise. The balance sheet should have a clear des­ig­na­tion of the different items on the balance sheet. This means that different types of assets and li­ab­il­it­ies should not be combined or offset against one another, and balance sheet items that are subject to dis­clos­ure should be included. Ad­di­tion­al items may be included if it is important for the balance sheet’s clarity. Detailed ex­plan­a­tions of the values need to be collected in notes so that the balance sheet can be read clearly.
• Balance sheet accuracy: The balance sheet needs to be complete and correct – you must not omit values or add figures that do not cor­res­pond with the truth. Values given in the balance sheet must be correct.
• Balance sheet con­sist­ency: A company’s different annual financial statement should be able to be compared quickly. For this reason, the rules stating how to prepare annual accounts are the same every year. For example, annual financial state­ments are always prepared for the same day. The sequence of different items and their names should not change con­stantly either. This is the only way to ensure that there is con­tinu­ity.
• Example: Let’s say for the sake of clarity that you combined several items on your balance sheet last year. This summary should not be dissolved when the next annual financial statement is being made. That would result in the balance sheets being in­com­par­able. This principle pre­scribes a seamless change from one fiscal year to the next. The opening balance sheet must cor­res­pond to the closing balance sheet from the previous year. This means that all items, quant­it­ies and values must be the same in both balance sheets.

Ma­ter­i­al­ity: The ma­ter­i­al­ity principle is an ac­count­ing rule that dictates any trans­ac­tions or items that sig­ni­fic­antly impact the financial state­ments and should be accounted for using GAAP ex­clus­ively.

As pre­vi­ously mentioned, there is no legal re­quire­ment to adhere to these prin­ciples. They are simply con­sidered an aspect of best practice and can help you create accurate, con­sist­ent records.

The aim of these guidelines is to make a balance sheet com­pre­hens­ible and mean­ing­ful, so that it provides a clear picture of a company’s economic situation. For example, these prin­ciples help prevent balance sheet fraud. This offence can lead to serious legal con­sequences.

All business owners must issue financial state­ments that include a balance sheet annually. This means that anyone involved in a business should be familiar with these guidelines. There are certain cir­cum­stances whereby a small business may be able to claim small company ex­emp­tions on their balance sheet statement. There are also some cir­cum­stances where a business owner may not be required to keep separate ac­count­ing records:

Sole pro­pri­et­ors: Sole pro­pri­et­ors are exempt from preparing balance sheets, since their revenue streams and expenses tend to be low, allowing them to use a pared-back book­keep­ing system based on cash flows. The most common system is usually a cash basis ac­count­ing system, which is a single-entry system.

If your business is classed as a public company, you are required to publish quarterly financial state­ments that are available to the public, as well as present your accounts to any business members at an annual general meeting (AGM). If your business is classed as a private company, then you are not obliged to make your financial state­ments public, and you are not obliged to present your accounts at an AGM. You just have to file your tax returns with the HMRC and oblige with any Companies House re­quire­ments you are bound by.  

If your business is a public company, then shares in your company are available for purchase. It also means that you owe trans­par­ency to your share­hold­ers, i.e. the public. Large re­tire­ment funds and non­profits may also be legally required to have audited financial state­ments. There can be ad­vant­ages and dis­ad­vant­ages to running a public or private company. If your company is private, then you have the benefits of con­fid­en­ti­al­ity, greater financial freedom, and an element of flex­ib­il­ity. On the other hand, if at any time you find yourself looking for outside help, either from a financial in­sti­tu­tion, angel investor or venture cap­it­al­ist, you may run into dif­fi­culties securing their as­sist­ance without providing a complete financial picture of the company

Ad­di­tion­ally, companies that issue financial state­ments often choose, or are obligated, to be audited by an in­de­pend­ent auditor. This means that an in­de­pend­ent examiner in­vest­ig­ates your company’s financial in­form­a­tion to prevent fraud. By law, public entities are required to have their financial reports audited, thanks to HMRC. Other companies may choose to have their reports audited to lend cred­ib­il­ity to their financial position.

Please note the legal dis­claim­er relating to this article.