Note that the Balance Sheet still balances. However, the lower initial investment is now insufficient to cover the cumulated losses during the first three periods. As a result, in period 3, the Assets (Cash) and Liabilities (Equity) become negative. Whilst this is correct from a pure calculatory perspective, it does not reflect the behaviour of the real-life situation: In practice, the business could not function with a negative cash balance, and may not be allowed to exist legally if equity were negative.
In real-life, the business would have to adapt, either operationally or financially. For example:
- By ceasing operations and closing down completely.
- By increasing the prices charged, so that the profit becomes higher.
- By reducing the costs (Product Costs or Fixed Operations Cost).
- … and so on.
Any such changes also need to be captured within the logic of the integrated financial model (change which we refer to as making “dynamic adjustments”). Such adjustments are sometimes called “dynamic balancing”, however, the need for the adjustments is to capture the real-life situation more precisely: The two sides of the Balance Sheet in any case always balance, even in the case where the figures are unrealistic or invalid.