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.