A:

Yes, a balance sheet should always balance. The name "balance sheet" is based on the fact that assets will equal liabilities and equity every time.

The assets on the balance sheet consist of things of value that the company owns or will receive in the future and which are measurable. Liabilities are what the company owes, such as taxes, payables, salaries and debt. The equity sections displays the company's retained earnings and the capital that has been contributed by shareholders.

The balance between assets, liability and equity makes sense when applied to a simpler example, such as buying a car for $10,000. In this case, you might use a $5,000 loan (debt), and $5,000 cash (equity) to purchase it. Your assets are worth $10,000 total, while your debt is $5,000 and equity is $5,000. In this simple example, assets equal debt plus equity.

The major reason that a balance sheet balances is the accounting principle of double entry. This accounting system records all transactions in at least two different accounts, and therefore also acts as a check to make sure the entries are consistent. Building on the previous example, suppose you decided to sell your car for $10,000. In this case, your asset account will decrease by $10,000 while your cash account, or account receivable, will increase by $10,000 so that everything continues to balance. (This is a very simple example. If you wish to learn more, check out Reading The Balance Sheet and Breaking Down The Balance Sheet.)

If the balance sheet you're working on does not balance, this should be a red flag that there is likely a problem with one or more entries. Even a small discrepancy can occur as a result of several errors that offset each other.

RELATED FAQS
  1. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The compound annual growth rate, or CAGR for short, measures the return on an investment over a certain period of time. Below ... Read Full Answer >>
  2. What are some examples of general and administrative expenses?

    In accounting, general and administrative expenses represent the necessary costs to maintain a company's daily operations ... Read Full Answer >>
  3. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  4. How do dividend distributions affect additional paid in capital?

    Whether a dividend distribution has any effect on additional paid-in capital depends solely on what type of dividend is issued: ... Read Full Answer >>
  5. Why can additional paid in capital never have a negative balance?

    The additional paid-in capital figure on a company's balance sheet can never be negative because companies do not pay investors ... Read Full Answer >>
  6. When does the fixed charge coverage ratio suggest that a company should stop borrowing ...

    Since the fixed charge coverage ratio indicates the number of times a company is capable of making its fixed charge payments ... Read Full Answer >>
Related Articles
  1. Fundamental Analysis

    Calculating Return on Net Assets

    Return on net assets measures a company’s financial performance.
  2. Credit & Loans

    What's a Nonperforming Loan?

    A nonperforming loan is any borrowed sum where the borrower has failed to pay scheduled payments for at least 90 days.
  3. Economics

    Understanding Cost of Revenue

    The cost of revenue is the total costs a business incurs to manufacture and deliver a product or service.
  4. Economics

    Understanding Cash and Cash Equivalents

    Cash and cash equivalents are items that are either physical currency or liquid investments that can be immediately converted into cash.
  5. Economics

    Explaining Carrying Cost of Inventory

    The carrying cost of inventory is the cost a business pays for holding goods in stock.
  6. Fundamental Analysis

    Is India the Next Emerging Markets Superstar?

    With a shift towards manufacturing and services, India could be the next emerging market superstar. Here, we provide a detailed breakdown of its GDP.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares Morningstar Small-Cap Value

    Find out about the Shares Morningstar Small-Cap Value ETF, and learn detailed information about this exchange-traded fund that focuses on small-cap equities.
  8. Investing

    How To Calculate Minority Interest

    Minority interest calculations require the use of minority shareholders’ percentage ownership of a subsidiary, after controlling interest is acquired.
  9. Mutual Funds & ETFs

    ETF Analysis: WisdomTree SmallCap Earnings

    Discover the WisdomTree Small Cap Earnings ETF, a fund with a special focus on small-cap and micro-cap stocks with positive earnings.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares US Regional Banks

    Obtain information and analysis of the iShares US Regional Banks ETF for investors seeking particular exposure to regional bank stocks.
RELATED TERMS
  1. Gross Profit

    A company's total revenue (equivalent to total sales) minus the ...
  2. Receivables Turnover Ratio

    An accounting measure used to quantify a firm's effectiveness ...
  3. International Financial Reporting Standards - IFRS

    A set of international accounting standards stating how particular ...
  4. Days Sales Outstanding - DSO

    A measure of the average number of days that a company takes ...
  5. Balance Sheet

    A financial statement that summarizes a company's assets, liabilities ...
  6. Equity

    The value of an asset less the value of all liabilities on that ...

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!