Net Worth of a Business - Business Studies Form 3 Notes

• Business Transactions
• Basic Terms Used in Business
• Book Keeping Equation
• Balance Sheet
  • Structure of Balance Sheet
  • Importance of Balance Sheet
  • Relationship Between Book – Keeping Equation and Balance Sheet
  • Net worth of a Business
• Past KCSE Questions On The Topic

Business Transactions

• These are all transactions that involve monetary values. It is not easy to memories all the business transactions hence a form of record is needed. When the recording is done in a systematic way it is called book – keeping.

Basic Terms Used in Business

1. Debtor
   - A person or organization who owes money to another.
2. Creditors
   - A person or organization to whom money is owed
3. Goods
   - These are items bought for the purpose of resale.
4. Assets
   - These are property of all kind owned by an individual, a business or any other organization and to which a monetary value is attached. There are two types of assets:
   
   Fixed assets
   - These are assets expected to last for a long time usually more than one year. They are not intended for resale but to help in the running of the business in order to produce and provide goods and services. Examples are buildings, land, motor cars and furniture.
   
   Current assets
   - These are assets which are expected to last for a very short period of tie usually less than one year. Examples include cash in hand, stock of stationery, debtors and prepaid insurance.
   
   Characteristics of Assets
   • A resource owned and controlled by the business.
   • Must have been acquired in the past.
   • An item of value that can be measured reliably in monetary terms.
   • May be either fixed or current.
5. Liabilities
   - These are borrowed money and items bought on credit, A liability is therefore what is owned to others. Examples are a loan borrowed, goods bought on credit, bills not yet paid etc.
   - There are two types of liabilities.
   • Long term liabilities
     - These are debts that are not expected to be settled within one year.
   • Short term liabilities
     - Debts that are payable within one year. For example bank overdrafts and debts for goods (creditors) payable within one month.
   
   Characteristics of a liability
   
   • It is a present obligation for a business to settle as a result of past commitment.
   • Its settlement may reduce business assets.
   • Amount involved can be measured reliably in monetary terms.
   • Owned to outsiders.
   • May be classified as a long term or short term (current liabilities).
6. Capital
   - This is money needed to start and run a business. Also called owners claims or owners' equity.

Book Keeping Equation

• The book keeping equation states that assets is equal to capital added to liabilities.
  Assets = Capital + liabilities
• The book keeping equation can be used to calculate the value of one item given the other two items as follows:
  A = C + L
  C = A – L
  L = A – C

Example

The following table contains information relating to a business A, B and C. Determine the figures
represented by W, X and Y.

Solution

Assets = Capital – liabilities

1. Capital = 620,000 – 230,000
   = 390,900
2. Assets = 400,000 + 120,000
   = 520,000
3. Liabilities = 800,000 – 500,000
   = 300,000

Balance Sheet

• This is a statement that shows the financial position of a business as at a particular date.
• It is usually prepared at the end of a trading period/accounting period.

Structure of Balance Sheet

The balance sheet should have the following:

1. Heading which should include:
   • Name of the business e.g. Bigfoot communications.
   • Name of the statement, i.e., balance sheet.
   • The data at which it is prepared ,e.g., as at 21st June 2005.The date is important because assets, capital and liabilities keep on changing as transactions take place and so the balance sheet can only be true at a specific time.
2. Assets ,capital and liabilities
   • Assets are recorded on one side and capital and liabilities on the other side.
   • The total of the two sides of the balance sheet sides must always be equal.

Example

The following balances were extracted from the books of Wasco traders on 30th October 1995.

Cash               20,520
Bank             160,230
Premises       800,000
Debtors          40,000
Creditors        62,000
2 year loan     40,000
Stock               2,500

Prepare a balance sheet

Solution

Note

• When the assets are more than the liabilities the balance sheet is said to be solvent.
• When liabilities are more than assets such that the difference between liabilities and asset the balance sheet is negative capital or deficiency. The business is said to be insolvent.

Importance of Balance Sheet

• A balance sheet provide useful information for decision making which may be used in the following ways:
  1. Financiers – To know wether the business is in a position to meet their claims
  2. Shareholders – To determine wether their funds are invested wisely.
  3. Government – As one of the documents required for taxation purposes.
  4. Potential investors – In order to make decisions on which shares to buy.
  5. The management – To compare their performance with previous years.

Relationship Between Book – Keeping Equation and Balance Sheet

• Book keeping equation also called balance sheet equation because balance sheet shows assets on one side and capital and liabilities on the other side which is a representation of the book keeping equation .
  A = C + L

Net Worth of a Business

• Net worth of a business simply refers to capital. It may be calculated by taking total assets and subtracting the liabilities.

Past KCSE Questions on the Topic

Paper 1

1. The following table contains information relating to a business A, B and C. Determine the figures represented by W, X and Y.
   

   Business	Assets	Capital	Liabilities
   A B C	620,000 X 800,000	W 400,000 500,000	230,000 120,000 Y

2. In the spaces provided, indicate with a (+) or (-) the effects of each one of the following transactions on the assets, Liabilities or capital (4 marks)
   

   a. Bought furniture on credit	Assets	Liabilities	Capital
   b. Paid creditors by cash
   c. withdrew cash for personal use
   d. Converted a personal car for business use

3. The following relate to business A, B and C. For each of the business determine the missing figures: M, N, and P
   

   Business	Assets	Capital	Liabilities
   A B C	30,000 n 60,000	m 16,000 48,000	12,000 13,000 p

4. For each of the following types of accounts, state in the spaces provided whether you debit or credit increase or decrease the account. (3 marks)
   

   Type of account	To increase	To decrease
   a. Asset account b. Liability account c. Capital

5. In the table below, determine the missing fig. X, Y and Z for each of business Q, R and S. –
   

   Business	Assets	Capital	Liabilities
   Q R S	250,000 Y 600,000	X 1,500,000 100,000	120,000 Z 400,000

   (3 marks)
6. The following information relates to business A, B, C and D.
   

   Business	Assets	Liabilities	Capital
   A B C D	500,000 Y 300,000 700,000	X 800,000 120,000 t	300,000 1,200,000 z 500,000

   Determine figure represented by X, Y, Z and T. (4 marks)