Liquidation balance sheets

When a company makes a loss, there is a risk that its equity capital will be eroded. Limited companies therefore have rules in place to protect the company's creditors. These rules mean that the board of directors must take action if the losses are so large that the company's equity capital is less than half of the registered share capital.

The first measure to be taken by the board in such cases is to immediately prepare a trial balance. The difference between a trial balance and a regular balance sheet is that assets may be reported at market value and that the company may use accounting rules other than those normally used if this means that the assets can be reported at higher values than in a regular balance sheet. If the company has an auditor, the balance sheet must then be reviewed by the auditor. The review is general in nature and cannot be compared to a full audit.

If the balance sheet shows that the company's equity exceeds half of the registered share capital, operations can continue. The balance sheet is a snapshot and, if losses continue, a new balance sheet may need to be prepared.

If the balance sheet shows that the company's equity is less than half of the registered share capital, the board of directors must convene a general meeting at which the owners shall decide whether the business should continue or be wound up. The meeting may also decide on various measures to increase equity, such as shareholder contributions or new issues at a premium. Once these measures have been implemented, the equity must exceed the entire registered share capital.

It is common for the shareholders' meeting to decide to continue operations for up to eight months in order to take measures to restore equity. Within these eight months, a new balance sheet must be drawn up. If this shows that the equity exceeds the entire registered share capital, the business can continue to operate. If the equity is less than the registered share capital, the company must be wound up. However, this does not happen automatically; in such cases, the board of directors must apply for liquidation. Following such an application, a liquidator is appointed with the task of winding up the business. It is very important to follow the formal rules in order to protect the members of the board, who may otherwise be held personally liable for the company's debts.