Accounting Equation

The equation is written as Assets = Liabilities + Equity. Assets are what the business owns or controls, such as cash, stock and equipment. Liabilities are what it owes, such as loans and unpaid supplier bills. Equity is what is left for the owners after liabilities are subtracted.

Suppose a small company has assets of 250,000 and liabilities of 90,000. Its equity must be 160,000. If the company then borrows 20,000 from a bank, its cash rises by 20,000, so assets become 270,000, and its loan rises by 20,000, so liabilities become 110,000. Equity stays at 160,000, and the equation still balances.

Every transaction keeps the two sides equal. Buying equipment with cash swaps one asset for another. Earning a profit increases assets and equity together. Paying a supplier reduces both cash and liabilities.

This is why the balance sheet always balances and why double-entry bookkeeping records every transaction in at least two places. The equation also makes an important point clear: borrowing to buy assets does not, by itself, make the owners any richer.