Is it ever legit to have Total Assets less than Total Liabilities?
December 10, 2023 8:20 PM Subscribe
I'm reading the financial statement of a charity that was submitted to the Canadian Revenue Agency. And the Total Assets is less than Total Liabiliities. I can understand if Total Assets is > Total Liabilities because sometimes Shareholders Equity is considered separately. But what possible situation would cause Total Assets < Total Liablilities in a formal balance sheet. It's supposed to balance!
Just because it's called a 'balance sheet' doesn't mean the assets and liabilities have to be equal ('balanced').
Where an organisation has higher liabilities than assets, it's not necessarily a bad thing, although it's a sign of potential issues. You need to also look at cash flow - if an organisation has sufficient cash flow to service its debt, it's not really an issue and it's common for non-profits to be in this situation. If an organisation has lower assets than liabilities and poor cash flow, that would be very concerning.
posted by dg at 9:22 PM on December 10, 2023
Where an organisation has higher liabilities than assets, it's not necessarily a bad thing, although it's a sign of potential issues. You need to also look at cash flow - if an organisation has sufficient cash flow to service its debt, it's not really an issue and it's common for non-profits to be in this situation. If an organisation has lower assets than liabilities and poor cash flow, that would be very concerning.
posted by dg at 9:22 PM on December 10, 2023
Total assets = Total liabilities plus total equity. The equity piece is important. And yes you can have negative equity.
The accounting reality can often be quite different from the "actual" financial reality of a company, depending on a lot of factors, because accounting conventions around how things are *ahem* accounted for don't always line up with how you think about things when you're trying to analyze a companies financials, instead of, well, making accounts line up.
posted by wooh at 9:37 PM on December 10, 2023 [9 favorites]
The accounting reality can often be quite different from the "actual" financial reality of a company, depending on a lot of factors, because accounting conventions around how things are *ahem* accounted for don't always line up with how you think about things when you're trying to analyze a companies financials, instead of, well, making accounts line up.
posted by wooh at 9:37 PM on December 10, 2023 [9 favorites]
I'm struggling to understand why assets and liabilities would be equal except by coincidence. If you have $100 and you owe your mate down the road $120 your assets are less than your liabilities. That's all it means.
Ordinarily, on a balance sheet, total assets should equal total liabilities plus shareholder equity. That is literally the fundamental balance sheet equation. In your example, you'd have $100 (assets) = $120 (liabilities) + -20 (shareholder equity). That's how you're supposed to write the balance sheet for accounting purposes, even though it's not exactly intuitive.
OP, assuming you're looking at an actual balance sheet (I don't know what Canadian charities submit to their regulator), this may be an accounting mistake (always possible) or it may be a very awkward way of showing that shareholder equity is negative. This is not necessarily catastrophic for a business, which may be highly leveraged and only focused on servicing the debt, but it is not a good sign for a charity, I'd think.
posted by praemunire at 9:39 PM on December 10, 2023 [1 favorite]
Ordinarily, on a balance sheet, total assets should equal total liabilities plus shareholder equity. That is literally the fundamental balance sheet equation. In your example, you'd have $100 (assets) = $120 (liabilities) + -20 (shareholder equity). That's how you're supposed to write the balance sheet for accounting purposes, even though it's not exactly intuitive.
OP, assuming you're looking at an actual balance sheet (I don't know what Canadian charities submit to their regulator), this may be an accounting mistake (always possible) or it may be a very awkward way of showing that shareholder equity is negative. This is not necessarily catastrophic for a business, which may be highly leveraged and only focused on servicing the debt, but it is not a good sign for a charity, I'd think.
posted by praemunire at 9:39 PM on December 10, 2023 [1 favorite]
It’s a charity, a non-profit, there wouldn’t be any shareholder equity.
For an otherwise healthy non-profit the balance sheet could go negative if they’ve borrowed against an asset that’s depreciated or otherwise lost value.
posted by ixipkcams at 11:14 PM on December 10, 2023 [2 favorites]
For an otherwise healthy non-profit the balance sheet could go negative if they’ve borrowed against an asset that’s depreciated or otherwise lost value.
posted by ixipkcams at 11:14 PM on December 10, 2023 [2 favorites]
That is literally the fundamental balance sheet equation. In your example, you'd have $100 (assets) = $120 (liabilities) + -20 (shareholder equity).
Well yes, but assets are still lower than liabilities in that calculation. I suppose using the language of the question the answer is that equity may be considered separately when assets are worth both more and less than liabilities.
posted by deadwax at 11:43 PM on December 10, 2023 [1 favorite]
Well yes, but assets are still lower than liabilities in that calculation. I suppose using the language of the question the answer is that equity may be considered separately when assets are worth both more and less than liabilities.
posted by deadwax at 11:43 PM on December 10, 2023 [1 favorite]
I suggested above that there's some chance OP may not have been looking at an actual balance sheet. In the United States, the short form smaller charities file (which is available publicly) has a line for Total Assets and a line for Total Liabilities. There is also a line for Net Assets, which is basically the nonprofit equivalent of shareholder equity, but that's not instantly obvious if you're thinking in terms of the corporate world. So if you're looking at that and you don't recognize the significance of the Net Assets line then you can't get the two sides of the equation to balance, as they should. But I don't know how they handle these kinds of disclosures in Canada.
Still think it's reasonable cause for concern if the non-profit's net assets go meaningfully negative.
posted by praemunire at 12:03 AM on December 11, 2023 [3 favorites]
Still think it's reasonable cause for concern if the non-profit's net assets go meaningfully negative.
posted by praemunire at 12:03 AM on December 11, 2023 [3 favorites]
If you have $100 and you owe your mate down the road $120 your assets are less than your liabilities.
Your assets are not just cash/the money on your checking account, but also things like real estate you own, your car, your computer, any appliances, equippment - things you bought and could sell, if you don't have enough cash to pay your debts.
If you your liabilities are higher than your assets, that means that you can't repay your debts, even if you sell everything you own. That is absolutely a bad thing. Nobody (who understands a balance sheet, I guess) is going to lend you any more money. The people who have lent you money so far, will have to write off most of it as a loss. For a business, that necessarily means game over. Nobody will do business with someone who can't meet their financial obligations. Negative equity means you have to file for banrkuptcy. If you wait too long to file for bankruptcy, you creditors might even take you to court for criminal delay of filing for bankruptcy.
Maybe creditors for a charity can be persuaded to write off a lot of that debt as a loss and turn it into a charitable donation?
posted by sohalt at 3:50 AM on December 11, 2023
Your assets are not just cash/the money on your checking account, but also things like real estate you own, your car, your computer, any appliances, equippment - things you bought and could sell, if you don't have enough cash to pay your debts.
If you your liabilities are higher than your assets, that means that you can't repay your debts, even if you sell everything you own. That is absolutely a bad thing. Nobody (who understands a balance sheet, I guess) is going to lend you any more money. The people who have lent you money so far, will have to write off most of it as a loss. For a business, that necessarily means game over. Nobody will do business with someone who can't meet their financial obligations. Negative equity means you have to file for banrkuptcy. If you wait too long to file for bankruptcy, you creditors might even take you to court for criminal delay of filing for bankruptcy.
Maybe creditors for a charity can be persuaded to write off a lot of that debt as a loss and turn it into a charitable donation?
posted by sohalt at 3:50 AM on December 11, 2023
If you your liabilities are higher than your assets, that means that you can't repay your debts, even if you sell everything you own. That is absolutely a bad thing. Nobody (who understands a balance sheet, I guess) is going to lend you any more money. The people who have lent you money so far, will have to write off most of it as a loss. For a business, that necessarily means game over.
It's not promising, for a non-profit in particular, but, as long as your current income allows you to meet your current expenses, the game is not over. On any given day, you are not called upon to liquidate all your assets to pay all of your debts or face default. Lenders often even wouldn't want you to do so, because they wish to collect as much interest as possible on the loan, especially when rates go down and they couldn't lend out the money at the same or a higher rate if they got it back (this is called "prepayment risk"). To give an example on the personal finance side, many young people with significant student loan debt, or people who went underwater on their residential mortgages in 2008, have or had a negative net worth (basically the equivalent of shareholders' equity for individual people). They are or were not necessarily going bankrupt, because their income was sufficient to make debt payments even if they could not pay off the loan in a lump sum.
If you wait too long to file for bankruptcy, you creditors might even take you to court for criminal delay of filing for bankruptcy.
Maybe this is a thing in Canada? I don't think I've ever heard of it in the U.S. Your creditors actually have the option of forcing you into bankruptcy, although for many reasons this is not a common move.
posted by praemunire at 8:54 AM on December 11, 2023 [2 favorites]
It's not promising, for a non-profit in particular, but, as long as your current income allows you to meet your current expenses, the game is not over. On any given day, you are not called upon to liquidate all your assets to pay all of your debts or face default. Lenders often even wouldn't want you to do so, because they wish to collect as much interest as possible on the loan, especially when rates go down and they couldn't lend out the money at the same or a higher rate if they got it back (this is called "prepayment risk"). To give an example on the personal finance side, many young people with significant student loan debt, or people who went underwater on their residential mortgages in 2008, have or had a negative net worth (basically the equivalent of shareholders' equity for individual people). They are or were not necessarily going bankrupt, because their income was sufficient to make debt payments even if they could not pay off the loan in a lump sum.
If you wait too long to file for bankruptcy, you creditors might even take you to court for criminal delay of filing for bankruptcy.
Maybe this is a thing in Canada? I don't think I've ever heard of it in the U.S. Your creditors actually have the option of forcing you into bankruptcy, although for many reasons this is not a common move.
posted by praemunire at 8:54 AM on December 11, 2023 [2 favorites]
It’s a charity, a non-profit, there wouldn’t be any shareholder equity.
Sure, it should be called an operating reserve or a fund balance or something similar, but it's functionally the same thing as shareholder equity. This should be negative if the liabilities are greater than the assets, but whoever prepared this statement probably didn't understand that.
posted by ssg at 10:38 AM on December 11, 2023 [2 favorites]
Sure, it should be called an operating reserve or a fund balance or something similar, but it's functionally the same thing as shareholder equity. This should be negative if the liabilities are greater than the assets, but whoever prepared this statement probably didn't understand that.
posted by ssg at 10:38 AM on December 11, 2023 [2 favorites]
Maybe this is a thing in Canada? I don't think I've ever heard of it in the U.S.
That's a good point, I'm not from Canada either, and apparently the laws really are stricter where I am (Austria) in this matter. Depending on the legal form of your business, you might be legally obliged to file for bankruptcy 60 days from knowledge of excess indebtedness/liabilities execeeding assets. Filing for bankruptcy doesn't have to mean that you have to liquidate all our assets on the spot, so "game over" was simply the wrong way to phrase that, and I want to apologize for being so facile about my choice of words -indeed Austrian creditors too often see a higher chance to get back more money if the business somehow can be saved. But you have to present a plausible plan for reorganisation, allowing creditors to recover a certain quota of their receivables, and they have to agree, at which point the whole affair is not going to end in bankruptcy but in re-organisation. So excess indebtedness really doesn't have to mean game over, but in Austria, it does mean that creditors have to be alerted to the problematic situation.
I'm sorry that I derailed this thread with irrelevant info about the legal situation in Austria; it didn't occur to me that things might be quite different elsewhere. German-speaking countries are apparently generally stricter about protecting creditors' interests.
posted by sohalt at 11:37 AM on December 11, 2023 [1 favorite]
That's a good point, I'm not from Canada either, and apparently the laws really are stricter where I am (Austria) in this matter. Depending on the legal form of your business, you might be legally obliged to file for bankruptcy 60 days from knowledge of excess indebtedness/liabilities execeeding assets. Filing for bankruptcy doesn't have to mean that you have to liquidate all our assets on the spot, so "game over" was simply the wrong way to phrase that, and I want to apologize for being so facile about my choice of words -indeed Austrian creditors too often see a higher chance to get back more money if the business somehow can be saved. But you have to present a plausible plan for reorganisation, allowing creditors to recover a certain quota of their receivables, and they have to agree, at which point the whole affair is not going to end in bankruptcy but in re-organisation. So excess indebtedness really doesn't have to mean game over, but in Austria, it does mean that creditors have to be alerted to the problematic situation.
I'm sorry that I derailed this thread with irrelevant info about the legal situation in Austria; it didn't occur to me that things might be quite different elsewhere. German-speaking countries are apparently generally stricter about protecting creditors' interests.
posted by sohalt at 11:37 AM on December 11, 2023 [1 favorite]
If you your liabilities are higher than your assets, that means that you can't repay your debts, even if you sell everything you own. That is absolutely a bad thing. Nobody (who understands a balance sheet, I guess) is going to lend you any more money.
Well, generally true but not always. There are some companies operating just with liabilities higher than assets, for several reasons, it's vaguely interesting, I think...
McDonald's famously has negative equity - currently $50 billion in assets, $56 billion in liabilities.
Their market cap - what investors value the company at - is $209 billion.
Starbucks is also in the same boat - $29 billion assets, $37 billion liabilities. Yet a $111 billion market cap.
You would ordinarily think that, well, if you have assets of $10 billion, and liabilities of $6 billion, the difference between the two - positive shareholders equity - would be the "value" of the company, right? If you bought the company today, and liquidated it, you would have $4 billion in change. But if your liabilities exceeded your assets, then the company would be worthless, because the business has more debts than it has assets.
So the first thing - accounting value of assets is almost always deeply conservative. For example, if you bought an asset, say some land, for $100 mil, and its market value went up in value to $500 mil... you'd still be recording it on the books as $100 mil. In theory, you could jump through hoops to try revalue it at $500 mil, but it just leads to a bunch of extra compliance, scrutiny and work for not much gain. Unless you're just about to be the target of a takeover or want to takeover another company yourselves and want to value your company properly. So McDonalds or a charity could have bought some land 50 years ago and it's still sitting on their books at some really low value. I don't know, maybe the charity has an old building its leasing out to a local university to have classes in, this is not uncommon, so it's generating revenue at current rates but valued on the asset sheet at a value from 50 years ago.
Furthermore, specifically in the case of McDonalds and Starbucks, their strongest assets are intangible - their brand. What they're actually selling - in the form of franchise fees - is the right to use their brand. So they have an extremely powerful asset that generates ridiculous revenue... that doesn't even appear on their balance sheet.
posted by xdvesper at 12:07 AM on December 12, 2023 [2 favorites]
Well, generally true but not always. There are some companies operating just with liabilities higher than assets, for several reasons, it's vaguely interesting, I think...
McDonald's famously has negative equity - currently $50 billion in assets, $56 billion in liabilities.
Their market cap - what investors value the company at - is $209 billion.
Starbucks is also in the same boat - $29 billion assets, $37 billion liabilities. Yet a $111 billion market cap.
You would ordinarily think that, well, if you have assets of $10 billion, and liabilities of $6 billion, the difference between the two - positive shareholders equity - would be the "value" of the company, right? If you bought the company today, and liquidated it, you would have $4 billion in change. But if your liabilities exceeded your assets, then the company would be worthless, because the business has more debts than it has assets.
So the first thing - accounting value of assets is almost always deeply conservative. For example, if you bought an asset, say some land, for $100 mil, and its market value went up in value to $500 mil... you'd still be recording it on the books as $100 mil. In theory, you could jump through hoops to try revalue it at $500 mil, but it just leads to a bunch of extra compliance, scrutiny and work for not much gain. Unless you're just about to be the target of a takeover or want to takeover another company yourselves and want to value your company properly. So McDonalds or a charity could have bought some land 50 years ago and it's still sitting on their books at some really low value. I don't know, maybe the charity has an old building its leasing out to a local university to have classes in, this is not uncommon, so it's generating revenue at current rates but valued on the asset sheet at a value from 50 years ago.
Furthermore, specifically in the case of McDonalds and Starbucks, their strongest assets are intangible - their brand. What they're actually selling - in the form of franchise fees - is the right to use their brand. So they have an extremely powerful asset that generates ridiculous revenue... that doesn't even appear on their balance sheet.
posted by xdvesper at 12:07 AM on December 12, 2023 [2 favorites]
I genuinely didn't know that thing about MacDonald's! But yeah, I really didn't think enough about market cap and brand equity, because I guess my frame of reference was too focussed on SMEs. But of course SMEs too could have significant hidden reserves.
I suppose in Austria you might be more motivated to jump through the hoops of revalueing assets, if you need to show your balance sheet to a bank to get a good credit rating for a loan. Banks just play a larger role in financing here, I guess. Of course that can also really backfire...
We just recently had a bit of scandal, when former golden boy René Benko had to file bankruptcy for Signa Holding. Lots of banks will be affected because they granted him loans backed by over-valued real estate. But yeah, whatever balance sheet he showed them didn't have negative equity...
Must have been so prevalent on my mind that I totally forgot assets can be undervalued too!
posted by sohalt at 3:32 AM on December 12, 2023
I suppose in Austria you might be more motivated to jump through the hoops of revalueing assets, if you need to show your balance sheet to a bank to get a good credit rating for a loan. Banks just play a larger role in financing here, I guess. Of course that can also really backfire...
We just recently had a bit of scandal, when former golden boy René Benko had to file bankruptcy for Signa Holding. Lots of banks will be affected because they granted him loans backed by over-valued real estate. But yeah, whatever balance sheet he showed them didn't have negative equity...
Must have been so prevalent on my mind that I totally forgot assets can be undervalued too!
posted by sohalt at 3:32 AM on December 12, 2023
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Personally my assets are currently lower than my liabilities because a bank owns a portion of my house. While I'm not thrilled about that it's not a problem.
Balance doesn't mean sum to zero, at least not in this case.
posted by deadwax at 8:33 PM on December 10, 2023 [4 favorites]