What Happens if a Balance Sheet Doesn’t Balance?
Written by Bindi Gethen
A balance sheet is a financial statement that outlines a company’s financial position at a specific point in time. It follows the fundamental accounting equation:
Assets = Liabilities + Equity
When your balance sheet isn’t balanced, you’ve gotten yourself more than just an accounting hiccup and a little oopsie. It’s a full-blown financial facepalm. You’re bleeding money, and you don’t even know where the wound is.
So what happens if a balance sheet doesn’t balance? This means that the total assets do not equal the total of liabilities and equity. This scenario necessitates immediate attention to locate and correct the discrepancies that arise from various possible issues like errors in calculation, omitted transactions, fraud or misrepresentation, incomplete transactions, software glitches, timing differences, and external factors.
What happens if a balance sheet doesn’t balance?
At its core, a balanced balance sheet represents equilibrium, where what a company owns (its assets) is mirrored by what it owes (its liabilities) plus what the owners themselves have invested (equity).
If a balance sheet doesn’t balance, it indicates a discrepancy between the total net assets and the sum of liabilities and equity, which should be equal. This imbalance typically signals errors in data entry, record-keeping, or arithmetic, which can stem from an overlooked transaction, a misclassified account, or simply a mathematical mistake.
Pro tip
An unbalanced balance sheet is a clear prompt for business owners and bookkeepers to investigate the reasons why the financial statements aren’t accurately reflecting the company's financial position.
Why your balance sheet is unbalanced
1. Errors in calculation
It’s human nature to err. Errors in calculations on a balance sheet can stem from simple data entry mistakes to complex accounting misapplications. Sometimes, they’re also caused by transposition errors where figures are reversed, or they could be the result of incorrect application of accounting principles, such as failing to amortise an intangible asset.
As mentioned, when errors occur, they ripple through the financial statements. For instance, an overstated asset inflates a company’s net worth on paper, possibly affecting everything from creditworthiness to investment decisions. On the flip side, an understated liability might paint an overly optimistic picture, leading to unsustainable dividend payments or reckless expansion plans.
The consequences of such mistakes are far-reaching, affecting not only internal decision-making but also external perceptions among investors, lenders, and partners.
2. Omitted transactions
This can happen for various reasons – maybe it was an oversight, maybe it was the rush of the day-to-day, or maybe it was something that didn’t seem important at the time. But just like in relationships, what we leave unsaid – or in this case, unrecorded – can lead to misunderstandings.
Individuals and businesses can establish a routine where all financial activity is documented and reviewed regularly. Leveraging bookkeeping software with bank feeds can reduce the risk of omissions by automatically recording transactions. I also recommend training staff to understand the significance of a vigilant financial culture within an organisation.
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3. Fraud or misrepresentation
Fraud can be a sign of deeper systemic issues. It’s a tough conversation, but it’s one that can ultimately lead us towards a more ethical, transparent, and robust way of doing things.
Fraud or misrepresentation in accounting can take many forms – from intentional misstatement of financial data to more egregious acts such as embezzlement or forging of financial documents. It’s a deliberate attempt to deceive stakeholders about the true financial position of an entity. The motivation behind such acts often involves personal gain or attempts to conceal the company’s poor performance.
Simply put, misrepresentation erodes trust (arguably the most critical asset of any business). It can lead to a plummet in stock prices, increased cost of capital, and can often be the precursor to stringent legal consequences.
Employees may become demoralised, and a culture of dishonesty can take root if not swiftly addressed. For the wider industry and economic ecosystem, incidents of fraud contribute to a sense of instability and can shake investor confidence.
4. Incomplete transactions
These are transactions that have been initiated but not fully processed or recorded. Examples include sales for which delivery has occurred but the invoice has not been issued, or goods received but not yet entered into the accounting system. These partial entries can lead to understatements or overstatements of revenue or expenses, thus misrepresenting the financial position and performance of a business.
These are transactions that have been initiated but not fully processed or recorded. Examples include sales for which delivery has occurred but the invoice has not been issued, or goods received but not yet entered into the accounting system. These partial entries can lead to understatements or overstatements of revenue or expenses, thus misrepresenting the financial position and performance of a business.
Case in point: if a company does not record an invoice for goods delivered, it will not recognise the revenue, leading to a mismatch between actual stock sold and sales reported. Similarly, if a company has received a service but has yet to process the expense, it may appear more profitable than it actually is during that period.
5. Software glitches
Financial software is the backbone of bookkeeping. A software glitch, which could be due to a bug in the system or an error in data input, can result in incorrect calculations, duplication of entries, or missing transactions. These glitches can cause significant issues, such as incorrect financial statements, which in turn play a role in misguided business decisions.
Pro tip
You’ll need IT, bookkeeping, and accounting professionals to work together to identify the root cause and correct the immediate issues. This process can be time-consuming and costly.
6. Timing differences
Timing differences, also known as cut-off errors, arise when there is a mismatch between the time a transaction is conducted and the time it is recorded in the financial statements. This can occur due to the nature of accrual accounting, where the recognition of revenue and expenses is not always synchronised with the associated cash flow.
From a business operations perspective, timing differences can impact an entity’s ability to manage cash flow effectively. They can also affect budgeting and forecasting since the financial statements may not accurately reflect the business’s operations within the relevant timeframe.
Take, for example, in the mining sector, where the sale of extracted minerals may be recognised upon shipment, but the cash receipt occurs at a later date. If the revenue is not recorded in the appropriate period, it could lead to significant timing differences, impacting financial results.
7. External factors
External factors are variables outside of a company’s control that can impact its financial position and operations. These can range from economic downturns, changes in market demand, regulatory changes, to natural disasters. Each of these has the potential to disrupt the normal course of business and lead to imbalances in the balance sheet if not properly anticipated and managed.
In detail, an economic downturn can lead to decreased sales, bad debts, and inventory obsolescence, all of which would affect the balance sheet. Regulatory changes could result in unexpected costs or require changes to accounting practices. Natural disasters might cause asset impairments or loss of inventory.
Business owners would need to engage in risk management, financial literacy, and contingency planning. They should diversify their operations where possible and keep abreast of economic and regulatory trends to be able to adapt quickly. For individuals, this might mean diversifying investments and being prepared for economic downturns with savings or other safety nets.
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Let’s make sure everything adds up
We all make mistakes and trust me, it’s going to be okay. You’ll find that pesky little discrepancy and when you do, the sense of relief is sweeter than the perfect cup of coffee on a Monday morning.
Should you ever need a second set of eyes, feel free to reach out to us at The Bookkeeping Studio. With our team in your corner, you can bid farewell to the days of scratching your head over spreadsheets. When your finances are in line, the rest just falls into place. Let experienced bookkeepers help you make everything add up today.
Hey, my name’s Bindi Gethen! I’m the founder of The Bookkeeping Studio in Australia. With over 15 years of experience in the industry, I have a deep understanding of the challenges that small and medium-sized business owners face when it comes to managing their finances.
I am passionate about empowering my clients with the financial information they need to succeed. My team and I pride ourselves on our commitment to exceptional value, accuracy, and confidentiality. Our virtual bookkeeping services include payroll, budgets, and management reporting, among others.
Not to toot our own horn, but we can assure you that you won’t find a bookkeeping partner like us anywhere else in the Southern Highlands.
