Why must a balance sheet balance?

Answer 1

A balance sheet is an accounting tool used to track assets, liabilities and equity. It must balance because it tracks the wealth of the company. If you start with a value at the beginning of a month, say $5.00 and you know this is accurate because of past balances, you can measure the value of the company by determining the equity. The equation is Equity = Assets - Liability. The balance sheet must balance because it is a simple math equation. As previously stated, you know you started with an equity value of $5 at the beginning of this month; if you make $5 more on sales (cash assets) but spend $4 to make and sell your widgets, the equity earned is only $1.

Assets = $5

Less

Liabilities = $4

Plus

Starting Equity =$5

________________

= $6

$6 is the value of your company at that specific point in time.

Since most businesses run on credit and sell on credit you may not have $6 in cash which is why accurate accounting is necessary. You may have been paid immediately for your sale and still owe the manufacturer for the cost of the widget. If you were to simply count the money you have on hand, you would find you have $10 when in fact you actually only have $6 because you owe $4 to the manufacturer.