2.1.6 The Balance Sheet

Welcome to On Judgement. Harbour has £100m of book equity. Does that mean shareholders could sell their investment for £100m today? Take a first view. You can change it when you have considered the evidence.

Assets are economic resources controlled by the business under the applicable framework. Liabilities are obligations; equity is the residual accounting interest. Assets equal liabilities plus equity. Current/non-current classification includes operating-cycle and other criteria, not just a simple twelve-month rule. A balance sheet reports carrying amounts under accounting rules; it is not a catalogue of immediately available sale proceeds.

Cash can be restricted; receivables may be slow or doubtful; inventory may be obsolete. Equipment may need replacement. Acquired goodwill reflects part of an acquisition accounting allocation, rather than a separately tradable cash balance. A right-of-use asset records a lease right under the relevant rules. Ask how each asset contributes to future cash and what evidence supports its carrying amount.

Read trade payables, borrowing, lease liabilities, tax and provisions alongside maturity and security notes. Current ratio = current assets/current liabilities, but a high ratio does not guarantee cash is available on payment dates. Some cash-collecting businesses operate with negative working capital. Debt risk depends on cash generation, refinancing, covenants and liquidity, not a universal safe ratio alone.

Equity changes with profit, distributions, share transactions and other reserves or comprehensive-income movements. Market capitalisation equals share price times the relevant shares, and may differ greatly from book equity. Neither a premium nor discount gives a complete investment answer. Unrecognised earning power, asset quality, leverage and expected returns can explain differences; price still requires a reasoned valuation.

Let's work through Harbour at year-end · £m. Current assets: cash 30, receivables 48, inventory 32. PP&E is 90. Current liabilities total 50, consisting of trade payables 35 and other current liabilities 15. Non-current debt is 50. Equity is 100. No other balances. Pause here and try the calculation or reasoning before continuing.

Current assets = 30 + 48 + 32 = 110; total assets = 110 + 90 = 200. Total liabilities = 50 + 50 = 100; assets = 100 liabilities + 100 equity. Working capital = 110 − 50 = 60; current ratio = 110/50 = 2.2:1. Debt less cash = 50 − 30 = 20 under this simplified debt definition; this is not total liabilities less cash.

Receivables and inventory make up £80m of current assets. Investigate timing and quality before calling the company liquid.

Now try the choices in this lesson. If your answer changes, identify the reason. Distinguish book value from market value. Use the case activities to put the idea into your own words, and return to the evidence when more than one conclusion is defensible.