Liabilities give you information about where the money came from. Equity and debt are the main parts. In addition there’s another in-between form: provisions. We look at these three in more detail.
Equity is made up of two parts: external equity and internal equity.
Capital (external equity)
This is the money which the company receives from the shareholders, the shareholders are the owners of the company.
Reserves (internal equity)
If a business is profitable, the shareholders decide what happens to the profit. If they decide to keep it in the company, to finance further impact, we call this ‘internal equity’ reserves (or retained earnings). Principally, this is also the shareholders money as it’s their company. Legal forms for social entrepreneurs usually provide limits on the distribution of profits to owners.
The financial layman might associate reserves with cash. As we will see later, these savings do not always show up as cash. Cash is the amount of money which is ready to use available in your pocket or on your bank account. Reserves are liabilities, they’re part of the balance sheet. They express the source of money, the explain where the money comes from. In the case of reserves, it comes from previous profits. And this money will be used to buy assets, not to stay safe on the bank account.
Debts consist of two parts:
These are the debts which need to be repaid on more than one year, such as long term bank loans.
These are the debts which need to be repaid within the current book year. This item includes both the proportion of long-term loans due for repayment within the year and other debts such as suppliers’ invoices still to be paid
Provisions are costs which are expected, but not yet paid. As long as these costs have not yet been paid, they can be used to finance the company. An example is the provisions of large scale maintenance. You can find the provisions between equity and debt, because they have characteristics of both. It is not really a debt, because provisions have no repayment schemes. On the other hand they are not equity because they are costs which are very likely to be made at a given time.
Let’s look at an example before we go on.