 |
| Image: Moneybestpal.com |
A key idea in accounting is the "accounting equation," which outlines the connection between a company's assets, liabilities, and owner equity. Assets = Liabilities + Owners' Equity is how the accounting equation is written. This means that the total worth of a company's assets must always equal the sum of its liabilities and owners' equity.
The resources that a business possesses and manages with the hope that these resources would produce future financial benefits are referred to as assets. There are two types of assets: current (such as cash and accounts receivable) and non-current (e.g. property, plant, and equipment).
A company's liabilities are its debts to third parties and are evidence of its claims against its assets. Accounts payable and short-term loans are examples of current liabilities (e.g. long-term loans).
After liabilities are subtracted from assets, a company's owner's equity is the remaining ownership stake. Retained earnings and capital are the next two divisions that can be made. While retained earnings are the profits that have been reinvested in the business over time, capital is the initial investment that the company's owners made in it.
The accounting equation is crucial because it offers a foundation for comprehending a company's financial situation. To keep the equation balanced when a company's assets grow, it must either grow its liabilities or owner’s equity. To preserve balance, a company's assets or owners' equity must decline if its liabilities rise.
