Assets, Liabilities, Equity: An Intro to the Accounting Equation

To run a financially-stable business, it’s important to know basic accounting principles and how to apply them to your business. The accounting formula is a foundational component of managing your balance sheets. Read more to discover how you can use the accounting formula to verify your assets, liabilities and equity.

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What is the accounting formula?

The accounting formula is a representation of a business’ finances in the form of assets, liabilities and owners’ equity that can help you determine the amount of money your company has in each category. Typically, professionals in financial roles, like accountants, use the accounting formula to complete company balance sheets, but in a small business or sole proprietorship, the business owner may complete these calculations themself.

The accounting formula is as follows:

Assets = Liabilities + Shareholder’s Equity

When you add your total liabilities and total equity, the result should equal your total assets.  If the two figures aren’t equal, then review your calculations to make sure you entered everything correctly. Check each account on your balance sheet and compare it to your company’s financial documents to see if you missed anything. This helps ensure that you report the correct figures when completing your taxes.

 

For example:

After you’ve checked your balance sheet and have made calculations , you determine that you have $300,000 in total assets, $250,000 in total liabilities and $50,000 in shareholder’s equity. This is what your formula should look like:

Assets = Liabilities + Shareholder’s Equity

$300,000 = $250,000 + $50,000

$300,000 = $300,000

 

What is an asset?

An asset is anything of monetary value to your company. Assets can contribute to your business’ day-to-day operations and promote potential financial growth or stability. There are two key types of assets: 1) current assets and 2) non-current assets. A current asset is typically only of value to your company within one fiscal year of purchase, while a non-current asset brings value to your company over a period longer than one fiscal year.

Here are examples of current and non-current assets and how to calculate them:

 

Examples of current assets 

  • Accounts receivable
  • Pre-paid liabilities
  • Cash
  • Stock inventory
  • Short-term investments (treasury bills, high-yield savings accounts and government bonds)

 

Examples of non-current assets

 

Calculating assets

For calculating assets, you can use the standard accounting formula or the following equation:

Total Assets = Current Assets + Non-Current Assets

To find your company’s total assets and compare them to the sum of your liabilities and shareholder’s equity, first identify the different types of assets on your balance sheet. Once you locate your total current and non-current assets, add them together to get your total assets.

For example:

Total Assets = $100,000 (Current Assets) + $200,000 (Non-Current Assets)

Total Assets = $300,000

 

What is a liability?

A liability includes any debts that a company owes to consumers, partners or institutions. Similar to assets, liabilities can be separated into two key categories: 1) current liabilities and 2) non-current liabilities.Current liabilities include any debts that your company needs to pay off within one fiscal year, while non-current liabilities include any debts that you can pay beyond one fiscal year.

Here are examples of current versus non-current liabilities and how to calculate them:

 

Examples of current liability

  • Accounts payable
  • Dividends
  • Wages
  • Income tax
  • Short-term bank loans
  • Notes payable

 

Examples of non-current liability

  • Bonds payable
  • Retirement payments
  • Debentures
  • Deferred taxes

 

Calculating liabilities

You can calculate your company’s liabilities by using the following formula:

Liabilities = Assets – Shareholder’s Equity

To determine the total amount of liabilities, find the amount of total assets and equity on your balance sheet. You might need to apply the equity formula before you proceed.

For example:

Liabilities = $300,000 (Assets) – $50,000 (Shareholder’s Equity)

Liabilities = $250,000

 

What is equity?

Equity or shareholder’s equity represents the amount of money that would most likely be leftover if you liquidated all of your assets to pay off your liabilities. This amount also represents the money that shareholders would receive in exchange for their investment.

Here are some examples of equity and how to calculate it:

 

Examples of equity 

  • Retained earnings
  • Preferred stock
  • Common stock
  • Paid-in capital

 

Calculating equity

Calculate equity with the following equation:

Equity = Assets – Liabilities

To determine the amount of equity you could potentially have for your investors, identify your total number of assets and liabilities. You can typically locate these figures at the bottom of your balance sheet.

For example:

Equity = $300,000 (Total Assets) – $250,000 (Total Liabilities)

Equity = $50,000

By understanding the accounting formula and its role within your business, you can better monitor your businesses’ financial stability.

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