If you are a seasoned modeller then you have been here, deadline approaching and you check the Balance Sheet and all balances, all is fine.  You make some edits for the next 10 mins, return to the Balance Sheet and all is out of whack with frustrations building.  A balance sheet imbalance in a financial model is a clear sign something has gone wrong. The balance sheet must balance: assets must equal liabilities and equity. When it doesn’t, it’s a major red flag that calls the integrity of the entire model into question.

Balance sheet imbalances come in different forms. Some are small and fixed across time periods, while others increase or decrease over time. From our experience, each type of imbalance points to a specific kind of error.

This post covers common causes of balance sheet imbalances and gives tips to fix them. Ensuring the balance sheet ties is critical to having a trustworthy model.

Common Causes of Balance Sheet Imbalances

1. Mis-linked or Unlinked Cells – Financial models rely on cell references across various sheets. If a cell on your balance sheet isn’t linked correctly, it can cause an imbalance.  For example, if total assets are pulling from an incorrect sheet or wrong value, the balance won’t tie.
2. Incorrect Retained Earnings Calculation – This could happen if net income isn’t being added to retained earnings correctly or if there’s a mistake in how dividends are subtracted.  Retained earnings accumulate net income year after year. If your income statement doesn’t flow correctly into your retained earnings section, the balance sheet won’t balance.
3. Equity Adjustments or Opening Balance Errors – Manual changes to equity or opening balances often cause imbalances. If you’ve adjusted equity accounts or entered opening balances incorrectly, it can throw off the entire balance sheet.
4. Debt or Interest Miscalculations – Debt and interest calculations impact both the liabilities (debt) and income statement (interest expense). If these aren’t calculated correctly, the mismatch can create balance issues.
5. Circular References – Circular references, where cells depend on each other, can cause calculation errors that lead to balance sheet imbalances. These are common in models where interest on debt is calculated based on the ending balance.
6. Depreciation and Amortisation Mistakes – Depreciation (for tangible assets) and amortisation (for intangible assets) reduce asset values. If the formulas or references for these aren’t correct, the balance sheet may fail to tie over time.

How to Identify Fixed vs. Variable Imbalances

When a balance sheet doesn’t balance, you’ll often notice two main types of errors: fixed imbalances and variable imbalances.

• Fixed Imbalances (Same Difference Each Period)
• Symptoms: The balance sheet shows a constant difference between assets and liabilities + equity across all periods.
• What It Means: A fixed imbalance usually means there’s a one-time miscalculation or missing line item in the model. A common cause is an unlinked value or incorrect starting balance that repeats across time periods.
• Example: Suppose you forgot to link net income to retained earnings. This would cause a fixed difference that repeats across every period in your model.

Variable Imbalances (Growing or Shrinking Over Time)

• Symptoms: The imbalance changes over time, either growing or shrinking from one period to the next.
• What It Means: Variable imbalances usually mean there’s an issue in how certain items (like debt, depreciation, or working capital) are calculated over time. It’s a sign that the error is compounding.
• Example: If you miscalculate interest payments, the imbalance might increase over time, as the incorrect debt balance rolls forward with each period.

Steps to Fix a Balance Sheet Imbalance

• Check Opening Balances – Start by confirming that your opening balances are correct. If your starting numbers are off, everything that follows will also be off.
• Verify Retained Earnings and Net Income – Ensure dividends are deducted properly.  Check if the income statement is flowing correctly into retained earnings. Look for any formulas that are missing or incorrectly pulling from the income statement
  
• Review Equity Entries – If you’ve made manual adjustments to equity, check that they’re reflected properly. Also, ensure any external equity transactions (e.g., capital raises, buybacks) are modeled correctly.
  
• Recheck Debt and Interest Calculations – Confirm that debt schedules are accurate and that interest expenses are calculated based on the right ending debt balance. Errors in debt schedules often cause growing imbalances.
• Review Depreciation and Amortization – Verify that depreciation and amortization flow correctly from the fixed asset schedule into the balance sheet. Ensure that formulas are consistent across all time periods
  
• Trace Changes in Working Capital – Working capital changes (inventory, accounts receivable, accounts payable) affect both the balance sheet and cash flow statement. Check if working capital movements are modeled consistently
  
• Check for Circular References – If your model has circular references, turn off iterative calculations temporarily and try to trace the issue manually. Circular references can create unpredictable changes and imbalances over time.
  
• Use Diagnostic Tools – Many financial modelling tools and Excel add-ins offer diagnostic checks for balance sheet errors. Use these to automatically scan for inconsistencies.

Tips to Avoid Future Imbalances

• Use Error-Checking Functions: Leverage Excel’s built-in functions like SUM, IFERROR, and ISBLANK to highlight potential issues in real-time.
• Regularly Check the Balance Sheet: Don’t wait until the end to check the balance sheet. Periodically verify that it balances as you build out your model
• Build a Control Account: Use a “plug” account that automatically captures any discrepancies between total assets and total liabilities + equity. This won’t fix the issue, but it helps you identify when and where the problem started.
• Double-Check Links and Formulas: Pay extra attention to linking cells across the balance sheet, income statement, and cash flow statement. Ensure formulas are consistent and pulling from the right source.
• Keep the Model Simple: Avoid overcomplicating the model. More complex models introduce more chances for error. Stick to simple, clear calculations whenever possible.

A balanced balance sheet is a fundamental check for the accuracy and integrity of your financial model. An imbalance, whether fixed or variable, is a clear indication that something is wrong. By following the steps above, you can identify and fix the issue, restoring confidence in your model. Regularly checking for imbalances as you build your model will prevent major errors down the line.