| There are two key aspects to consider in a business | | | | financial analysis format the left column contains the |
| balance sheet, how efficiently it is funded ("Funding") | | | | funding entries (Debt and Equity), and the right column |
| and how efficiently it is operated ("Operations"). Both | | | | the operational entries (Working capital and |
| are important but separate parts of a business; the | | | | Non-current assets) . Instead of cash and overdraft |
| bank overdraft is part of funding. Changes to funding | | | | being included with Working Capital they are moved to |
| arrangements do not impact on operating | | | | the Debt section in the left column. The Debt section |
| performance. | | | | includes cash, bank overdraft and long term debt. All |
| Traditionally accounting balance sheets are arranged | | | | cash assets or cash liabilities are shown as debt (cash |
| into Assets, Liabilities and Equity in accordance with the | | | | is regarded as negative debt). |
| balance sheet equation i.e. Assets = Liabilities + Equity. | | | | In this format you can clearly see what effect an |
| With a two column format, Assets are in the left | | | | overdraft has on the balance sheet. An overdraft will |
| column and Liabilities and Equity on the right. In a | | | | raise debt. The overdraft affects the Income |
| traditional balance sheet Current Assets may contain | | | | statement because debt incurs interest (an expense) |
| "cash at bank" and Current Liabilities may contain | | | | so interest payments will rise, there will be less profit |
| entries for "bank overdraft". Both Current Assets and | | | | and therefore less tax to be paid. The retained income |
| Current Liabilities are components of Working Capital | | | | entry on the balance sheet (under Equity) will reflect |
| which is the operational aspect of the business. In | | | | this. However nothing on the Operations side of the |
| traditional accounting format it can therefore be difficult | | | | balance sheet will be affected by whether the |
| to distinguish funding from operations. | | | | operations are funded by debt or equity or both. |
| However the presence or absence of an overdraft | | | | Most businesses are financed by a combination of |
| only affects the funding aspect. This is clearly seen if | | | | equity and debt. Exactly what debt/equity mix |
| the format of the balance sheet is rearranged to | | | | (leverage) is best for the business is part of the |
| reflect the separation of Finance and Operations. In this | | | | funding strategy determined by management. |