Accounting a Very Short Introduction

“A balance sheet must balance because what a Business owns must equal to what it owes”

I always found this puzzling until I realised there is an unspoken assumption: there is an owner to the business that is separate from the business itself (cf. Accounting a Very Short Introduction OUP p.31).

This is why retained profits are treated as (positive) equity for the owner.

And also how (assuming an unlimited liability company) there can be negative equity for the owner: the owner has not only lost all her initial contributions, but will be liable for money that the company owes others.

Looking back, I was likely hampered by the incorrect assumption that a balance sheet somehow measures a (natural) person’s wealth. But this was not the original intellectual context and likely to lead to misunderstanding.

The point of balance sheets or double entry accounting is not to tell entrepreneurs how to make business decisions. It is to enable outside funders (e.g. shareholders, beneficiaries to a trust, bank lenders) to understand how a business is doing. It imposes a (sometimes) artificial language for the managers and employees to record and organise all the money matters. External auditors are there to check that the language is not stretched beyond breaking point, and to ensure the data-collection process is broadly robust and reliable.

It is therefore simply unhelpful to think of someone’s financial health in terms of a balance sheet: to do this, other people (e.g. parents and romantic partners’) contribution to her life needs to be reckoned as some kind of equity that can be withdrawn at will. Nothing would truly belong to this person on that analysis.