Interpreting and understanding accounts
An ACCA case study

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Page 4: The Balance Sheet

Is £1 million a good profit? The question, of course, is meaningless. For a local family firm, a million pounds would be astounding. However, for a large company like Halfords it would be a disaster. We need to relate profit to the value of resources used in its generation. So, what is the value of the resources contained within a business? And how were they financed? These are the two essential questions answered by the Balance Sheet. They are also the questions that explain the basis of the term ‘Balance Sheet’. The total value of resources must ‘balance’ with the sources of finance used in obtaining those resources. All resources on the Balance Sheet are called assets while sources of finance are called liabilities.

Acca 18 Diagram 4This is the Balance Sheet for Halfords plc. It starts with the assets. Non-current assets (£442m) are the long-term investments made by the business in property and equipment. Also included are intangible assets that represent invisible value, for example, reputation or patents. Next it shows the current assets (£205m), which flow through the business as sales are made. The usual items are stock, debtors and cash.

The current liabilities (£178m) are debts that must be paid in less than a year. These often relate to goods bought on credit. The non-current liabilities (£182m) are mainly long-term loans. Net assets are simply the excess of assets over liabilities (£647m minus £360m = £287m). This surplus is called total equity (also £287m). It is these two items that make the modern Balance Sheet balance.

Careful reading of a company’s Balance Sheet can be highly revealing. The difference between current assets and current liabilities is called net current assets or working capital. This indicates the extent to which the business has everyday funding to keep trading and not to run out of cash. By contrast, capital employed is a measure of the long-term resources in use by the business. It consists of the total equity plus non-current liabilities (loans). For Halfords, this is £287m + £182m = £469m. This leads us to the most important single indicator of business success, the Return on Capital Employed (ROCE). This relates operating profits to capital employed as a percentage. For Halfords this gives (£97m/£469m) X 100 = 20.7%. This is a much better rate of return than any offered by a bank.

ACCA | Interpreting and understanding accounts