Basics of Accounting Equations – Part I

Wednesday, June 21, 2017

The financial status of any company is measured by the amount of resources it has along with any claim to those resources the company may have. Claims are also known as equities. So the company financial status would be its economic resources plus the equities, which can be of two types irrespective of the nature of business. These are creditor’s and the owner’s equity. Economic resources are thus made up of two components: creditor’s plus owner’s equity.

In accounting terms, the owner’s equity is also called their ‘assets’ and the creditor’s equity is known as the company’s ‘liabilities’. So the standard accounting equation stands at: Assets=Liabilities + Owner’s Equity. As in any equation, both sides of the equation have to be equal. This equation is important if you wish to analyze the financial health of your company through its daily business activities.

Let us look at an important financial aspect of any business. Assets of a company are its economic resources from where they can earn income in the future. An example of this is real estate or any other property which the company owns, which they can rent out if they want. If the company is owed money, then it is entered under a heading, called accounts receivable, which is purely monetary in nature. However, there are many assets which a company may own which are not tangible or physical in nature. Copy rights, trademarks and patents are some examples of this type of assets which are equally valuable as an economic resource.

Liabilities on the other hand are business obligations which a company carries. Examples are cash payable, providing various types of services to individuals or transferring their assets to another entity. These are known as debts of a company or the money they owe to the market or can owe in future. Legally speaking, having a lot of debts, liabilities and claims are not viewed favorably by any authority as it reflects directly on the financial health of the company. By law the creditors or the people/entity who the company owes money can push the company to sell off its assets if their dues are not paid on time. Creditors yield a lot of power over the owners of the company as they have to be paid their dues in advance, even before the owner has received money. In fact, sometimes a situation may arise that the debts are so high that it eats into the all of company’s economic resources.

Owner’s equities are claims which the business owners make on their own assets. The residual interest is the balance assets of a company which is available after deducting the entity liability amount. Hence the owner’s equity equation is: Owner equity=Assets-Liabilities. When it is a corporation, the owner’s equity can also be referred to as stockholder’s equity. So the equation changes slightly reading as: Assets=Liabilities +Stockholder’s Equity.

Darren Williger is a tea drinking, meditating, low carbohydrate eating, wine making sales maker who writes for, and

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