Lessons · Accounting · the accounting equation
The one equation the whole of accounting sits on
What the business has equals what it owes plus what is left over for the owner: Assets = Liabilities + Equity.
Hone is a place to practise a career, one idea a day. This is one of its lessons, written out in full and free to read without an account.
What it is for
The owner asks what the business is worth on paper, and the answer is the right-hand end of this line. At month-end, when a balance sheet will not balance, this equation is the first thing you check, because every entry ever made had to keep it true.
How to think about it
Write the three words across the page. Put every balance you know under one of them. Whichever word is empty is the one the equation gives you.
Worked example
Assets = Liabilities + EquityThe equation. Everything the business has was paid for either by somebody it owes or by its owner.
Assets: cash 8,000 + van 12,000 = 20,000What the business has, added up. Cash in the bank and a van in the yard.
Liabilities: bank loan 5,000What it owes. The bank lent 5,000 towards that van.
Equity = 20,000 − 5,000 = 15,000What is left for the owner once the bank is paid. Rearranged: assets minus liabilities.
Your turn
A shop has assets of 30,000 and owes 11,000. Write the line that gives the owner's equity.
Equity = 30,000 −
Solve one, graded on the server
The trap
Thinking equity is a pile of money somewhere. It is not; it is a claim on everything the business has, after the lenders. A business with 15,000 of equity may have 200 in the bank.