An investor could always invest into the company by paying off a loan, thereby increasing net assets and his ownership interest (contributed capital – equity). Cash from operations can also pay off debt, but this is the result of earnings so you are not reducing retained earnings directly. Retained earnings can be distributed to shareholders via a cash dividend, thus reducing both assets and equity, but yes that would also mean net assets represent the retained earnings, and only transactions that reduce liabilities increase the ratio. Basically the closer the ratio is to one the more assets are owned instead of financed.

Revenues do not necessarily throw off the balance sheet, but is more or less just held temporarily in the income statement since the balance sheet does not represent that period until the income statement is closed. But to see how balance sheet accounts are currently affected, you can think of revenues as increasing equity and expenses as decreasing equity since these are essentially what closing entries do.

Kenneth

In that case would you say the last paragraph below is a true statement about deleveraging?

Deleveraging is selling assets & using the proceeds (cash) to retire debt. Spending cash to retire debt will shrink the balance sheet.

Capital Ratio = Equity Capital/ Total Assets

You can’t deleverage through retained earnings. Retained earnings have no effect on the capital ratio since that increased equity (numerator) was offset by increased assets (denominator) earlier. Revenues increase assets (cash or accounts receivable) which throws the balance sheet out of balance. Retained earnings (moving net income from the income statement to the balance sheet) only bring the balance sheet back in balance.