Most balance sheets are prepared in a format where a bundle of assets and liabilities are “financed by” the ownership interest. This is the format prescribed by the Companies Act 2006, which is in turn based upon the Fourth Directive of the European Union. Businesses which are not companies are free to prepare their accounts in any format which they find useful, and might like to consider the other principal format. This has the profit shown in the profit and loss account as the bottom line being replicated as the top line on the balance sheet. The profit feeds into the ownership interest, which “represented by” a bundle of assets and liabilities. We can show profits, then drawings, then a subtotal, and then other movements in business capital. The “represented by” section then appears as a confirmation of the calculation.
Many traders who are told by their accountant that a profit has been made may wonder where it has all gone. Generally it has gone on drawings during the year, and some analysis may be provided between drawings taken as ready cash and other private payments such as tax. We feel that this presentation will be more useful for a trader who does not intend to incorporate at any time, and offer it as a choice.
The “represented by” balance sheet looks a bit like a cash flow statement drawn up by the indirect method, and in our opinion it makes a sensible alternative for a small business, even granting that it is strictly a flow of funds statement rather than a flow of cash statement. Some banks may like cash flow statements because they are harder to manipulate using accounting provisions and estimates. However, a cash flow statement is another page in the accounts (more trees to chop down) and half the numbers in it could be negative, which makes it difficult to read. We will offer a choice of a cash flow statement if the bank really wants one, but suggest the “represented by” format for unincorporated businesses as a sensible middle way.
It is acknowledged that I learnt about all this while working for other accountants, and I have put together what I feel to be best practice. I suspect that the cash flow statement is a good idea which many people will say they want, but it is rarely read in practice. I won’t argue about it, and will give the client and the client’s bank a choice, but the alternative form of the balance sheet deserves a mention.