WHAT IS A BALANCE SHEET?

In my years of financial training, I have noticed that a large number of executives go through life using the word 'balance sheet' without really knowing what it means.  They know that it's one of the key accounting documents, but that's about as far as the knowledge goes.

In essence, a balance sheet is a statement, at a particular date, of financial position, showing what is owned by the person/business, and what is owed to others.

If you got a piece of paper and wrote out your own personal balance sheet, what would it look like?  Well, it would, primarily, list out the assets that you own.  For accountants, assets are items of future economic value.  The balance sheet lists assets in two separate categories: those which are expected to last for more than one year (non-current assets), and those which will last for less than one year in their present form (current assets).  So, your personal list might include:

NON-CURRENT ASSETS
Any land and buildings you own
Any equipment, vehicles and furniture you own

CURRENT ASSETS
Any money owed to you by friends, relatives etc
Any short-term stock (e.g. food in the freezer)
Any cash in the bank

But you not only have assets, you have liabilities - amounts you owe to others.  So you will deduct:

NON-CURRENT LIABILITIES
Any money due to others after one year, such as your long-term mortgage liability

CURRENT LIABILITIES
Any money owed on credit cards (this is current because the lender can claim it at any time)
Any short-term borrowing such as bank overdrafts
Any unpaid goods and services, where you have received the benefit, but not paid for it yet

The total of your assets, less your liabilities, equals your equity.  If the number is positive, then you are solvent.  If it's negative, then you are insolvent, and may have borrowed too much!

That's it, simple as that.  If you work for an organization, it will usually produce a balance sheet at the end of the year, to show its financial position.

In summary, a balance sheet shows:

1. Assets with a future value lasting more than one year (non-current assets)
2. Assets with a future value lasting less than one year (current assets)
3. Liabilities to be repaid after more than one year (non-current liabilities)
4. Liabilities to be repaid within one year (current liabilities)
5. The net balance of assets less liabilities, which is called equity.  If equity is positive, the person/organization is solvent.

WHY IS GREECE IN TROUBLE?

The Greek government owes about 340 billion euros.

Let's get some perspective on that. I find the best way to understand big numbers is to scale them down.

Let's imagine the Greek government is a man who owes $34,000 to the banks. Let's evaluate his financial position.

MR GREEK GOVERNMENT: INCOME AND EXPENDITURE

2009: earned $4,800, spent $7,800 - $3,000 too much! Not good.

2010: earned $5,300, spent $7,200 - $1,900 too much! Better, but still not good.

2011 plan: aims to earn $5,600, and spend $7,200 - $1,600 too much! When will he learn?

What would you say to someone who consistently earned around $5,000, but spent around $7,500?

Would you say he was likely to repay his debts of $34,000?

No. So everyone in Europe is giving up, and letting him off at least half the debt, as long as he reins in his spending.

WHAT ABOUT MR UK GOVERNMENT?

Let's do the same thing with the UK.

Mr UK Government earns and spends about 10 times more than Mr Greek Government.

2009: earned $53,000, spent $63,000 - $10,000 too much!

2010: earned $52,000, spent $67,000 - $12,000 too much!

2011 plan: aims to earn $55,000, aims to spend $70,000 - $15,000 too much!

Would you say he was likely to repay his debts of $90,000?

Well, as a proportion of his income, the debt is a bit more manageable.

But Mr UK Government's overspending, as a proportion of his debt, is actually worse!

EVALUATING MR UK GOVERNMENT

Most official evaluations suggest Mr Greek Government will not repay his debt - he has the world's worst credit rating.

Most official evaluations suggest Mr UK Government will repay his debt - he has the worlds best credit rating.

WHY THE BIG DIFFERENCE IN CREDIT RATING?

Imagine a herd of sheep in a field, surrounded by wolves.

Some sheep are in the middle of the herd, and some on the edge.

The sheep are the governments of Europe, and the wolves are the creditors.

Which sheep are most at risk? - the ones on the edge.

The Greek Government is on the edge; the UK Government is near the middle of the herd.

The wolves are picking off the sheep on the edge.

Therefore, it is the wolves' priorities, not the sheep's, which explain the situation!

IN SUMMARY

Mr Greek Government earns $5k, spends $7k, and owes $34k. He has the world's worst credit rating.

Mr UK Government earns $50k, spends $70k, and owes $90k. He has the worlds top credit rating.

AFTERTHOUGHT

Mr Saudi Government earns about $20k and spends about $17k, a surplus of about $3k.

He only owes about $8k.

All very sensible.

Yet he has only the fourth best credit rating on the scale - worse than Mr UK Government.

BUSINESS AND CHILDHOOD

Last night, over a dinner with some great friends, one friend told me all about her son's new venture.

He has ganged together with some schoolfriends in a new activity which is keeping them all obsessed. They buy bargain food and drink from the Co-op in multipacks, and then sell them to their school colleagues.

I was amazed at how they all seemed to be learning, in practice at an early age, all the lessons I teach in my finance courses!

1. They had decided to stick to bargain purchases only (cost-leading strategy based on purchasing strength)
2. They chose not to pay themselves anything, but to store all their money for future purchases in a money box (nil-dividend strategy due to inventory demands in a fast-growing start-up)
3. They had each taken a responsibility: one managed drinks, one chocolate, and one other snacks (business segmentation and company structure)

There was much more they had learned and planned. For instance, others now wanted to come in on the venture, but they had decided to limit the stakeholders for the moment.

Very wisely, his mum balanced the business interest with social responsibility:

"What are you going to do with the profits?" she said. "Had you thought about making a contribution to charity?"

He paused.
"We haven't really thought about it yet Mum. But it's a good thought."

What a brilliant mini-education!

Maybe eventually they will become competition for the school canteen, and become subject to government regulation!

But, until that time, they have an opportunity to learn so much. They can learn about patiently working hard, and getting back some reward. They can learn about working together, the arguments it can cause, and how to develop some patience to resolve the problems. I wish them lots of luck and success!

In debt - what are the options?

I am often asked what the options are when in financial difficulties. Many people know about bankruptcy as an option, but don’t necessarily know how to go about it, or the pros, cons and alternatives. This is a brief summary.

Bankruptcy is a way of getting rid of your debts. You can declare that you are unable to pay everything off by making a 'petition' (i.e. request) to a relevant local County Court. The cost is a court fee (£120), a deposit towards costs (£250), and sometimes a fee to swear or confirm your financial position (£7). The court then makes a 'bankruptcy order', and appoints the Official Receiver (a person who works for the court) to control your finances for at least a year. Your bankruptcy is registered, and published. From that moment you stop using your existing bank account, and stop paying your debts.

Within 21 days of the Order, you must list all assets and debts for the Official Receiver. You must report all your income, and any assets you have, or any extra funds above normal living expenses, should go to pay back your debts.

During the period of bankruptcy, you cannot borrow more than £250 without telling the lender you are bankrupt. You can open a bank account, but can't have an overdraft. At the end of the period (often a year, sometimes more), you are 'discharged' - that is, the court declares that you are free of the debts.

A bankruptcy stays on your credit record for six years. Even after that, you may be asked (e.g. by mortgage providers) to state if you have been bankrupt.

Alternatives to bankruptcy include:

1. Informal arrangements. You agree reduced payments with your creditors, but they can reverse their decision at any time.
2. Individual voluntary arrangements. A professional insolvency practitioner (IP) acts as intermediary. You pay the IP, and they pay the creditors. The IP charges you a fee.
3. Debt management plans. A debt management company helps you make a plan and agreement with your creditors. As with informal arrangements, creditors don't have to stick to the plan.
4. Administration orders (only for debts totalling < £5,000). The court acts as intermediary and takes a 10% fee.
5. Debt relief orders (only for < £15,000 where you have <£50 per month spare income and < £300 in assets). Student loans don't apply. An authorized debt adviser applies to the Official Receiver on your behalf. The application fee is £90. This is very like bankruptcy, but slightly cheaper and simpler to administer, and you are less likely to have to attend court.
6 Fast-track voluntary arrangements. Involves the Official Receiver. Relevant if you have easily saleable assets and want to cancel a recent bankruptcy quickly by cutting a deal.

For more on debt options the follwing Government link is good:
http://www.direct.gov.uk/en/MoneyTaxAndBenefits/ManagingDebt/Debtrepaymentoptions/DG_10023185

For more on debt relief orders, see the following from the Citizens Advice Bureau:
http://www.adviceguide.org.uk/index/life/debt/debt_relief_orders.htm

I hope this all helps!