Why Does a Balance Sheet Need to Balance? (2024)

FAQs

Why Does a Balance Sheet Need to Balance? ›

It provides transparency in your accounting, showing a clear list of company assets and how they are funded. There should always be a clear balance between assets, liabilities, and equity. The purpose of a balance sheet is not only to show your finances to investors, however.

The two halves must balance because the total value of the business's assets will all have been funded through liabilities and equity. If they aren't balancing, it can only mean that something has been missed or an error has been made.

The accounting equation will always balance because the dual aspect of accounting for income and expenses will result in equal increases or decreases to assets or liabilities.

The assets and liabilities of your company should be equal to each other for your balance sheet to tally. A mistake in the balance sheet will render it unbalanced. As a result, it will make the decision-making of your company difficult which may affect your profitability as well.

Many experts believe that the most important areas on a balance sheet are cash, accounts receivable, short-term investments, property, plant, equipment, and other major liabilities.

Your balance sheet gives you a summary of your company's financial position at a point in time and provides a clear picture of what you own and what you owe.

Rule #1: Assets = Liabilities + Equity

It's always in balance because it tells the story about how your assets are financed. This is known as the capital structure of your company. Think about owning a home. The home is an asset, the mortgage is a liability, and equity is the difference.

Like any equation, each side will always be equal. In the accounting equation, every transaction will have a debit and credit entry, and the total debits (left side) will equal the total credits (right side). In other words, the accounting equation will always be "in balance".

The accounting equation has to be in balance after every transaction in a business. The business transaction includes three elements i.e. asset, owner equity, liability.

The balance sheet is based on the fundamental equation: Assets = Liabilities + Equity. As such, the balance sheet is divided into two sides (or sections). The left side of the balance sheet outlines all of a company's assets.

Does the balance sheet matter? ›

Balance sheets are also important because these documents let banks know if your business qualifies for additional loans or credit. Balance sheets help current and potential investors better understand where their funding will go and what they can expect to receive in the future.

You'll usually find a box to check on your business tax return to indicate that it's a final return, but you'll also be able to show that your business has wrapped up successfully by preparing a balance sheet that has zero balances for all the accounts of the business.

Key Takeaways

Off-balance sheet (OBS) assets are assets that don't appear on the balance sheet. OBS assets can be used to shelter financial statements from asset ownership and related debt. Common OBS assets include accounts receivable, leaseback agreements, and operating leases.

It is important for businesses to keep track of their corporate balance sheet because it can provide insights into their financial health. Accounting teams can use balance sheets to forecast future performance and make decisions about how to grow the business.

The three golden rules of accounting are (1) debit all expenses and losses, credit all incomes and gains, (2) debit the receiver, credit the giver, and (3) debit what comes in, credit what goes out. These rules are the basis of double-entry accounting, first attributed to Luca Pacioli.

If the asset is valued on the balance at market value, then its book value is equal to the market value. Ways of measuring the value of assets on the balance sheet include: historical cost, market value or lower of cost or market.

In other words, the sum of your company assets, liabilities and equity should always balance to zero. If you generate a balance sheet report that does not equal zero, the balance sheet is out of balance and there may be an error in the ledger transactions.