5.1 Sole Traders

A sole trader is a business owned and run by one person, where there is no legal distinction between the owner and the business. The owner receives all the profits but is also personally liable for all the business's debts.

Statement of Financial Position (SFP) - Understanding the Inter-relationship of Items

The Statement of Financial Position (SFP), also known as the Balance Sheet, provides a snapshot of a business's assets, liabilities, and equity at a specific point in time. The fundamental accounting equation governs the relationship between these elements:

Assets = Liabilities + Equity

This equation must always balance.

Key Components of a Statement of Financial Position for a Sole Trader

Let's examine the key components of a SFP for a sole trader:

• Assets: What the business owns.
• Liabilities: What the business owes to others.
• Equity: The owner's stake in the business.

Assets

Assets are resources controlled by the business that are expected to provide future economic benefits. Common assets for a sole trader include:

• Cash at Bank: Money held in the business's bank account.
• Cash on Hand: Physical cash held by the business.
• Fixtures, Fittings and Equipment (FFE): Items used in the business, such as furniture, computers, and machinery.
• Inventory/Stock: Goods held for sale.
• Debtors: Money owed to the business by customers for goods or services supplied on credit.

Liabilities

Liabilities are obligations of the business to external parties. Common liabilities for a sole trader include:

• Overdraft: A facility provided by a bank that allows the business to spend more money than it has in its account.
• Creditors: Money owed by the business to suppliers for goods or services purchased on credit.
• Loan from Bank: A sum of money borrowed from a bank.
• Tax Liability: Money owed to the government as a result of income tax or other taxes.

Equity

Equity represents the owner's capital investment in the business plus any retained profits. For a sole trader, it typically consists of:

• Capital: The initial amount of money the owner invested in the business.
• Retained Profit: The accumulated profits of the business that have not been distributed to the owner.

Table Summarising the SFP

Item	Example	Amount (£)
Assets	Cash at Bank	$1,500
Assets	Cash on Hand	$200
Assets	Fixtures, Fittings and Equipment	$5,000
Assets	Inventory	$3,000
Assets	Debtors	$1,000
Liabilities	Overdraft	$500
Liabilities	Creditors	$2,000
Liabilities	Loan from Bank	$8,000
Liabilities	Tax Liability	$1,000
Equity	Capital	$10,000
Equity	Retained Profit	$2,500

The Accounting Equation in Action

The total assets of a sole trader must always equal the sum of their liabilities and equity. For example:

$$\text{Assets} = \text{Liabilities} + \text{Equity}$$$$$1,500 + $200 + $5,000 + $3,000 + $1,000 = $5,000 + $2,000 + $8,000 + $1,000 + $10,000 + $2,500$$$$$12,700 = $28,500$$

This example shows that the equation does not balance. This indicates an error in the recorded figures.

Importance of a Statement of Financial Position

A Statement of Financial Position is crucial for a sole trader as it provides a clear picture of the business's financial health. It helps the owner to:

• Assess the business's solvency (ability to pay its debts).
• Make informed business decisions.
• Understand the owner's stake in the business.
• Monitor changes in the business's financial position over time.