Midnight on 31 December: The year is over at Lena's Bakery Ltd. Lena and Marco write down three things.
The three lists
- Everything the business has at this moment: the Mill Lane bakehouse and its ovens, the vans, $25,000 in the bank, flour in the store.
- Everything it owes: Valley Grain's flour bill, the overdraft, what is left of the bank loan for Mill Lane.
- One more line: what is left over for the owners.
That list is the balance sheet (its full name is the statement of financial position). It shows what a business owns and what it owes on one date.
The profit and loss account from 3.4.1 covers a whole year, like a film of the year. The balance sheet is a photograph of a single day, and it carries that date in its heading.
Assets: what it owns
- The Mill Lane bakehouse, its ovens and the vans
- Cash in the bank and the flour in the store
- Money the cafés and hotels owe for bread already delivered
Liabilities: what it owes
- The flour bill still to be paid to Valley Grain
- The overdraft at the bank
- The rest of the bank loan that paid for Mill Lane
Equity: the owners' stake
- The money the shareholders put in for their shares
- Profit kept in the business over the years instead of paid out
- It belongs to Lena, Marco and Marco's cousin
Take away everything the bakery owes from everything it owns and you get what the business is worth to its owners (net assets). That same amount is the owners' stake (total equity).
Net assets always equal total equity. That is why it is called a balance sheet: the two halves are two ways of looking at the same money.
| Lena's Bakery Ltd at 31 December 2025 | $ |
|---|---|
| Total assets (everything it owns) | 760,000 |
| Total liabilities (everything it owes) | 410,000 |
| Net assets (760,000 − 410,000) | 350,000 |
| Total equity (share capital 200,000 + retained earnings 150,000) | 350,000 |
The two figures that must match: Net assets and total equity. If they differ when you build a balance sheet, a line is in the wrong place or a sum is wrong. Find it before you move on.
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The ovens at Mill Lane will bake for years. The flour in the store will be bread by Friday.
Both are things the bakery owns, but one stays for a long time and the other turns into cash within days. A balance sheet sorts every line by that difference.
The one-year rule: Current means it will turn into cash, or has to be paid, within a year. Non-current means it is kept, or owed, for longer than a year.
So there are current and non-current assets, and current and non-current liabilities.
| Line | Where it goes and what it is | Lena's Bakery Ltd |
|---|---|---|
| Property, plant and equipment | Non-current asset: buildings, machines and vehicles, at what they cost | Bakehouse, ovens and vans, $770,000 |
| Accumulated depreciation | Taken off the line above: the wear recorded so far | ($90,000), leaving $680,000 |
| Cash | Current asset: money in the bank and the tills | $25,000 |
| Debtors | Current asset: customers who owe the business money | Cafés and hotels, $40,000 |
| Stock | Current asset: materials and goods waiting to be used or sold | Flour and ingredients, $15,000 |
| Creditors | Current liability: suppliers the business owes money to | Valley Grain, $45,000 |
| Bank overdraft and short-term loans | Current liability: borrowing repaid within a year | $15,000 |
| Borrowings, long-term | Non-current liability: loans repaid over more than a year | Bank loan for Mill Lane, $350,000 |
| Share capital | Equity: money the owners paid for their shares | $200,000 |
| Retained earnings | Equity: profit kept in the business over the years | $150,000 |
Ovens and vans wear out. The fall in an asset's value as it is used and gets older is its depreciation. So the balance sheet shows what they cost, $770,000, and takes off the wear recorded so far, $90,000, in brackets. What is left, $680,000, is the bakery's non-current assets.
Debtors or creditors?: Debtors owe the bakery money: the cafés and hotels, $40,000. That is an asset, because the money is coming in.
Creditors are owed money by the bakery: Valley Grain, $45,000. That is a liability, because the money is going out. These are the two words most often swapped.
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A balance sheet is always built in the same order, from the top. Every block ends in a subtotal.
The order: the heading and date, the assets, the liabilities, net assets, then equity. Here is Lena's Bakery Ltd's, one block at a time.
Building the bakery's balance sheet
Heading and date
Lena's Bakery Ltd. Statement of financial position (balance sheet) as at 31 December 2025. Without the name and the date it is not finished.
Assets
Non-current: $770,000 − $90,000 = $680,000.
Current: cash $25,000 + debtors $40,000 + stock $15,000 = $80,000.
Total assets = $680,000 + $80,000 = $760,000.
Liabilities
Current: creditors $45,000 + overdraft $15,000 = $60,000.
Non-current: bank loan $350,000.
Total liabilities = $60,000 + $350,000 = $410,000.
Net assets
Total assets − total liabilities = $760,000 − $410,000 = $350,000.
Equity
Share capital $200,000 + retained earnings $150,000 = $350,000, the same as net assets. It balances.
| Lena's Bakery Ltd: statement of financial position as at 31 December 2025 | $ | $ |
|---|---|---|
| Non-current assets | ||
| Property, plant and equipment | 770,000 | |
| Accumulated depreciation | (90,000) | |
| Non-current assets | 680,000 | |
| Current assets | ||
| Cash | 25,000 | |
| Debtors | 40,000 | |
| Stock | 15,000 | |
| Current assets | 80,000 | |
| Total assets | 760,000 | |
| Current liabilities | ||
| Creditors | 45,000 | |
| Bank overdraft | 15,000 | |
| Current liabilities | 60,000 | |
| Non-current liabilities | ||
| Borrowings, long-term | 350,000 | |
| Non-current liabilities | 350,000 | |
| Total liabilities | 410,000 | |
| Net assets | 350,000 | |
| Equity | ||
| Share capital | 200,000 | |
| Retained earnings | 150,000 | |
| Total equity | 350,000 |
Leave the year's trading out: A table in a question often mixes in sales revenue, cost of sales, expenses, interest or tax. Those belong to the profit and loss account (3.4.1), not the balance sheet.
Before you start, tick the lines you will use. Anything about the year's trading stays out.
Buying something moves figures around the balance sheet. What changes depends on how it is paid for, and in both cases below net assets stay at $350,000.
Card tills, $9,000, paid in cash
- Cash falls by $9,000: current assets go from $80,000 to $71,000.
- Non-current assets rise by $9,000: from $680,000 to $689,000.
- Total assets stay at $760,000. One asset has been swapped for another.
A deck oven, $45,000, on a bank loan
- Non-current assets rise by $45,000: from $680,000 to $725,000.
- Non-current liabilities rise by $45,000: the loan goes from $350,000 to $395,000.
- Total assets and total liabilities both rise by $45,000, so it still balances.
Two changes, never one: Every purchase changes two lines by the same amount: an asset up, and either another asset down (paid in cash) or a liability or share capital up (paid with a loan or new shares). That is why it still balances.
What is a name worth?: On a Saturday morning the queue at the High Street shop runs out of the door. People come for Lena's sourdough, and for the name above the window they have trusted for years.
Nobody can touch that name or pick up that recipe. Yet both bring money in every day.
Assets you cannot touch, but that still bring money into a business, are intangible assets. They are kept for years, so they sit with the non-current assets on the balance sheet.
Most of them are rights: the right to be the only one who makes, copies or uses something.
| Type | What it is | Example |
|---|---|---|
| Patent | The only right to make, use or sell a new invention for a set number of years | A new dough mixer design, registered by the firm that invented it |
| Copyright | The only right to copy a creator's work, such as writing, music or software | A cookbook of the bakery's recipes |
| Trademark | A registered name, logo or phrase that marks out one firm's products | Goldcrust's golden-loaf logo |
| Brand value | What a well-known brand is worth to the business that owns it | The Goldcrust name across 400 bakeries |
| Goodwill | The extra paid for a business above the value of its net assets | See Goldcrust's purchase below |
| Licences and franchises | The right to use someone else's name, product or system for a fee | A licence to sell a famous coffee brand in the shops |
| Software, domain names and customer lists | Programs, a website address, a list of loyal buyers | The bakery's online ordering site and its list of wholesale customers |
Goodwill at Goldcrust: Goldcrust plc buys a regional chain of 40 bakeries for $10 million. The chain's net assets (its buildings, ovens and stock, less what it owes) are worth $7 million.
Goldcrust has paid $3 million more than the net assets, for the chain's name, its loyal customers and its good locations. That $3 million goes on Goldcrust's balance sheet as goodwill.
Intangible assets matter because they are often where a firm's advantage lies. A patent stops rivals copying an invention. A trusted brand lets a business charge more and keep its customers. Goodwill shows that a bought business was worth more than the things it owned.
Built or bought: A brand a business builds for itself never appears on its own balance sheet: nobody paid a price for it, so its value is only an estimate.
Lena's name is worth a great deal, but it is not on her balance sheet. The same kind of value appears only when a business buys another one, as goodwill.
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The van from 3.2.4: Lena and Marco buy the new delivery van for $36,000. After four years of 5 a.m. runs they expect to sell it for about $12,000.
The cost of using it: So using the van for four years costs the bakery $24,000. Which year does that cost belong to? A little to each of them.
Spreading the cost of a long-term asset over the years it is used is depreciation. The simplest way takes off the same amount every year: the straight-line method.
Annual depreciation = (original cost − residual value) ÷ useful life in years
The residual value is what the asset can be sold for at the end. The useful life is how many years the business expects to use it.
The van, straight line
What will be used up
Original cost − residual value = $36,000 − $12,000 = $24,000.
Spread it evenly
$24,000 ÷ 4 years = $6,000 a year.
Write the answer with its sign
Annual depreciation = $6,000. Show the working line; a bare 6,000 is not enough.
| End of year | Depreciation | Accumulated depreciation | Net book value |
|---|---|---|---|
| 1 | $6,000 | $6,000 | $36,000 − $6,000 = $30,000 |
| 2 | $6,000 | $12,000 | $36,000 − $12,000 = $24,000 |
| 3 | $6,000 | $18,000 | $36,000 − $18,000 = $18,000 |
| 4 | $6,000 | $24,000 | $36,000 − $24,000 = $12,000, the residual value |
Net book value: Net book value = original cost − accumulated depreciation. It is what the asset is worth in the accounts: the accumulated depreciation line on the balance sheet, worked out for one asset.
An expense, but no cash: Each year's $6,000 is also an expense in the profit and loss account (3.4.1), so it lowers profit, yet no cash leaves the bakery that year. The cash left when the van was bought.
When a question gives a fleet of identical assets, work out one and multiply. Twenty cars at $50,000 each, residual value $5,000 each, five years: ($50,000 − $5,000) ÷ 5 = $9,000 a car, × 20 = $180,000 a year.
Two slips that cost the answer: Forgetting to take off the residual value first: $36,000 ÷ 4 = $9,000 is wrong.
Stopping at one asset when the question asks for all of them, or leaving the $ sign off the answer.
The van will not drive the same distance every year.
Year 1, new
- Takes the long wholesale runs to the cafés and hotels.
- 40,000 km.
Year 4
- Only does the short hop between Mill Lane and the shops.
- 20,000 km.
Straight line charges the same $6,000 in both years. But the van wears out faster in the busy year.
Depreciation that follows use: The units-of-production method charges depreciation for how much the asset is used: kilometres driven, loaves baked, machines made.
Depreciation for a year = (units this year ÷ units over its whole life) × (original cost − residual value)
| Year | Kilometres | Units of production | Straight line |
|---|---|---|---|
| 1 | 40,000 | 40,000 ÷ 120,000 × $24,000 = $8,000 | $6,000 |
| 2 | 35,000 | 35,000 ÷ 120,000 × $24,000 = $7,000 | $6,000 |
| 3 | 25,000 | 25,000 ÷ 120,000 × $24,000 = $5,000 | $6,000 |
| 4 | 20,000 | 20,000 ÷ 120,000 × $24,000 = $4,000 | $6,000 |
| Total | 120,000 | $24,000 | $24,000 |
The same $24,000 comes off in total either way. The methods differ only in when: units of production takes more in the busy years and less in the quiet ones.
Another way to work it: $24,000 ÷ 120,000 km = $0.20 a kilometre, then × the kilometres driven that year.
Straight line
- Suits assets used about the same amount every year: ovens baking every night, shop fittings, tills
- Simple, and the same charge every year
- Ignores that use varies, and that many assets lose most value early
- Rests on guesses of life and residual value
Units of production
- Suits assets whose use rises and falls: vans by kilometres, machines by output
- Matches the charge to the wear, so the value in the accounts is truer
- A light first year means a small charge and higher early profit
- Needs a guess of lifetime units and a record of use every year
Which for the bakery?: The Mill Lane ovens bake about 1,200 loaves every night of the year. Their use hardly changes, so straight line fits them.
The van's kilometres follow the wholesale orders, and they change from year to year. Units of production fits the van.
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