As accountants, we inevitably get asked questions about finance all the time, and that’s great! However, it’s never fun when we have to explain to someone that their accounting is messed up. Unfortunately, having negative balances is one of the classic tells of accounting problems.
Examples Of Negative Balances
Your company’s balance sheet is a really important part of startup accounting (check out our page on balance sheets and our video for more info!). It‘s essentially a snapshot of what your assets, liabilities, and equities look like at a given point in time. Negative balances in your balance sheet could include:
- Accounts payable being a negative number
- A negative number for a current loan
Having any kind of negative number on your balance sheet indicates that something is really wrong in your finances.
How Do Negative Balances Occur?
An incorrect negative balance is commonly caused by a simple miscategorization - a bookkeeping mistake. Someone may have mistakenly put a liability in an asset account or vice versa. Another reason you may see a negative balance can be incorrect amortization. Amortization is the process of periodically reducing the book value of an asset over a set period. So your accountant may not book a monthly amortization. Or they might amortize the full amount at once, which could cause problems. Or they may have gotten ahead of themselves and accidentally double-booked an entry.
There are many things that lead to a negative balance, so it’s difficult to go into every possible reason. However, the main message we want to get across is that negative balances on the balance sheet means something is wrong and it’s important that you investigate!
Look At The Reasons For The Negative Balances
While negative balances on a balance sheet are generally a cause for concern, they don’t always indicate severe financial problems. The context, reason behind the negative balance, and the company’s overall financial health are crucial factors in determining the severity of the problem.
Specific Issues
- Negative cash balance. This usually indicates an overdraft, which can signal poor cash management or liquidity issues.
- Negative retained earnings. Often referred to as an accumulated deficit, this suggests that a company has more losses than profits over time.
- Negative shareholder equity. This can occur when liabilities exceed assets, signaling that the company might be in financial distress.
While negative balances can indicate problems, they can also be signs that a startup is doing better than expected. Here’s a breakdown of the pros and cons of negative balances:
Pros
- Overpayments. A negative balance in accounts like liabilities or expenses might indicate an overpayment, such as a prepayment of expenses or taxes, which could be advantageous in managing future cash outflows.
- Strong collections. A negative accounts receivable balance could indicate that a company has collected more cash than expected, possibly due to prepayments from customers, which improves cash flow.
- Aggressive debt repayment. A negative balance in loan accounts might suggest that a company has paid down its debts ahead of schedule, reducing future interest expenses.
- Potential tax benefits. Negative retained earnings (accumulated losses) can sometimes result in tax benefits, such as the ability to carry forward losses to offset future taxable income.
- Transparency. Negative balances can provide transparency into the financial situation of a company, highlighting areas that need attention or adjustment.
Cons
- Signal of financial trouble. Negative equity or retained earnings can indicate financial distress, accumulated losses, or a struggling business, which can concern investors, lenders, and stakeholders.
- Impact on borrowing. A negative balance, especially in equity or cash accounts, can make it difficult to secure financing or loans, as lenders may perceive the company as a higher risk.
- Potential for insolvency. Persistent negative balances, particularly in equity or retained earnings, can lead to insolvency or bankruptcy if not addressed, as they suggest that the company may not be able to meet its obligations.
- Investor confidence. Negative balances can erode investor confidence, leading to difficulties in attracting new investors.
- Misinterpretation. Stakeholders may misinterpret negative balances as a sign of poor management or financial instability, even if the negative balance has a justifiable reason, such as a strategic prepayment or an unusual one-time event.
Negative Balances Can Indicate Bad Finances
Here at Kruze Consulting, we do multiple levels of review on our clients’ accounts. We have three separate individuals who look into potential issues and determine the reason for any negative balances on balance sheets. If you’re seeing negative balances, that’s an indicator that there hasn’t been enough thorough checks being made, or there aren’t enough people to make those checks.
While negative balances on your balance sheet are usually not good, they are probably not the end of the world. They can typically be fixed easily once you understand the problem.
Get In Touch With Us At Kruze
If you’re a venture-backed startup in need of advice or help with negative balances, please do get in touch. Negative balances on your balance sheet are a big tell-tale sign that there is something wrong in your accounts. You need to get to the heart of the issue in order to understand what’s gone wrong and how to fix it.
If you have any other questions on negative balances, valuations, startup accounting, or taxes, please contact us. You can also follow our YouTube channel and our blog for information about accounting, finance, HR, and taxes for startups!
