“Don’t Lose Your Balance!!!” A “Foolproof” Method to Balancing Balance Sheets
Have you ever been there? It’s late at night, you’ve been slugging away at your model for days. Now comes the “pièce de résistance” – it’s time to get the balance sheet built and bring the model across the finish line. You link the final cells, build the final totals…and…OH NO!!! [cue the nasty sound when you get a wrong answer on the Family Feud]. The balance sheet doesn’t balance, every year by a different amount, and of course the imbalances have a million decimals!!!
Question: What should you not do?
Answer 1: “Plug” the balance sheet (i.e. enter hardcodes across one row of the Balance Sheet for each year that doesn’t balance).
Answer 2: Wire the balance sheet so that it always balances by making Retained Earnings equal to Total Assets less Total Liabilities less all other equity accounts.
This will definitely get it to balance, but you won’t know where you went wrong.
The Solution in 3 Easy Steps:
Getting a Balance Sheet to balance is easy when you realize there is one account that makes it balance – the Cash & Equivalents account. Simply put, all the items on the Cash Flow Statement need to have an impact on the Balance Sheet – on assets other than cash, liabilities or equity. The net of all those changes is the change in Cash & Equivalents which drives the ending Cash on the Cash Flow Statement (and therefore the Balance Sheet). If one or more of those movements are inconsistent or missing between the Cash Flow Statement and the Balance Sheet, then the Balance Sheet won’t balance.
Here are the steps to troubleshoot that imbalanced Balance Sheet, in order:
Check all your totals on the Balance Sheet to make sure no lines are being omitted. This is quick to check and may solve the issue right away (for example, people often forget to include Current Assets in the Total Assets summation).
Go down the Cash Flow Statement line by line (Operating, Investing and Financing activities) and ensure that the Balance Sheet is picking that item up in an account other than cash (assets, liabilities or equity), in the right amount and the right direction. Starting at the top of the Operating Activities section:
- Net Income would increase Retained Earnings (or decrease it if Net Income is negative)
- Depreciation would decrease Property, Plant & Equipment
- A Deferred Tax Expense add-back would either increase Deferred Tax Liabilities or decrease Deferred Tax Assets
- Working capital changes would affect the various accounts (make sure the signs / direction of cash flow is correct)
- And so on and so forth, keep going through every line of the Cash Flow Statement until you’re done
If the Balance Sheet still doesn’t balance after step 2, it can only mean one thing. It must mean there is at least one line on the Balance Sheet that is moving period to period without a corresponding Cash Flow Statement change or an offsetting Balance Sheet change. For example, maybe you’ve assumed that Other Long-Term Assets grow as a percentage of sales. That might be fine, but you’ll need to offset the increase in assets (perhaps with a cash outflow under Investing Activities on the Cash Flow Statement).
The Bottom Line
These three steps will work every time, as they ensure that the Cash Flow Statement and Balance Sheet are connected properly. Good luck!