By form of the balance sheet is meant its physical appearance—the arrangement and classification of its items. The form is not standard. In this country there are few legal regulations governing the way in which the records of a business are to be kept or its reports are to be made. Some efforts have been made, however, to establish a more or less standard form of balance sheet and to secure the use of standard titles in the balance sheet so that wherever found those titles can be relied upon to mean one and only one thing. Because balance sheets are not always drawn up for similar purposes, such regulations should not be too inflexible. The form of any business statement or report should always have regard to the purposes it is to serve. Standardization of form is desirable within this limitation.
By content of the balance sheet is meant the items that are admitted to it and the basis of their valuation.
These two problems of the balance sheet—form and content—are fundamental and will be briefly considered here.
Titles—Main and Group.—Instead of “Balance Sheet,” other terms are used as names for the statement itself, such as “Financial Statement,” “Statement of Resources and Liabilities,” “Statement of Assets and Liabilities.” Within the statement, Resources is an alternative title for Assets; and Net Worth, Present Worth, and Net Assets, for Proprietorship. For the present, use of the terminology previously employed will be continued, with the substitution, however, of the term Net Worth for Proprietorship.
The title of a statement should be full; it should include the name of the business enterprise and date, and should appear somewhat as follows:
Shongood & Goodwell
Balance Sheet
December 31, 19—
As stated, this should be followed by the schedules of Assets, Liabilities, and Net Worth. Since the statement is a formal one, due regard should be had for its general appearance, which should be neat and attractive. Further consideration will be given to some of these features in Chapters [XXVI] and [XXVII].
Classification and Arrangement.—As indicated above, the balance sheet is used to picture the financial condition of a business at a given time. Some of the questions which arise in determining the financial condition of a business have already been mentioned. The chief use to which a balance sheet is put is the determination of the solvency of the business for purposes of getting credit extensions. By solvency is meant the ability of the business to pay its debts when due. Regardless of how great the excess of assets over liabilities is, if it is tied up in assets which cannot be used for the payment of debts, the creditors of the business will become impatient and may ask a court to take the control of the business away from its owners and place it in the hands of a representative of the court and the creditors, who will conduct the business for the purpose of converting assets into cash to a sufficient extent to pay all debts.
A balance sheet should therefore be so arranged that the condition of the business, viewed from the standpoint of its ability to pay its debts, will be clearly and easily determinable. Cash is usually the only medium used for the payment of debts. In the regular course of business, debts are incurred which come due at different dates. Hence it is not necessary to have on hand at a given time cash sufficient to pay all of the debts of the business. Certain classes of debts will not wait. The sums owed employees for services must usually be paid when due. The debt to the government for taxes, to the public service company for heat, light, and power, to the landlord for rent, to the bank for money borrowed—all these debts must usually be paid immediately as they come due.
The cycle of business operation includes the purchase of merchandise, the payment of operating expenses, and the conversion of merchandise into cash through sale, either directly, as when the sale is for cash, or indirectly as when credit is extended a customer and cash is later collected from him. This cycle or turnover of merchandise recurs constantly in the management of the financial affairs of a business. It is necessary so to order the buying and selling of goods and the collection of accounts from customers that there will be on hand at all times sufficient cash to pay the expenses of operating the business and the debts contracted in the purchase of merchandise. This is the vital and fundamental problem of the business executive. In the solution of that problem it may sometimes be necessary to borrow funds from the bank. Before lending money, the banker assures himself that the business will be in a position to repay the borrowed money when due.