The Accounting Equation: Assets = Liabilities + Owners’ Equity

Your business is built on the accounting equation:

Assets = Liabilities + Owners’ Equity

Assets are what your business owns.  Liabilities are what your business owes.  The difference between these what you – the owner – actually own: owner’s equity.

Suppose your business has $100,000 in assets and $30,000 in liabilities.  Then $70,000 of your company ($100,000 – $70,000) actually belongs to you.

balance sheet ok

balance sheet ok by Philippe Put, on Flickr

This is similar to computing net worth (also, assets minus liabilities).

Suppose that you personally own $100,000 in assets (car, house, boat, etc.) and owe $30,000 in debt.  Then your personal net worth is $70,000.

In either scenario, if liabilities exceed assets, then your owners’ equity or net worth could actually be negative.

The accounting equation is used to organize the balance sheet.

It is important to pay careful attention to the balance between liabilities and owners’ equity.  How much of your company has been financed with liabilities ($30,000) versus owners’ equity ($70,000)?  The more liabilities, the greater the financial risk.

About Mark P. Holtzman

Chair of Accounting Department at Seton Hall University. PhD from The University of Texas at Austin. Worked at Deloitte's New York Office. BSBA from Hofstra University.

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Trackbacks/Pingbacks

  1. The balance sheet explained « Accountinator - March 28, 2012

    […] assets, liabilities, and owners” equity at a given point in time.  It follows the accounting equation and will help you understand a company’s solvency and […]

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