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Assets, Liabilities, Equity: What Small Business Owners Should Know
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Assets, liabilities and equity are the three largest classifications in your accounting spreadsheet. Assets are everything your business owns. Liabilities and equity are what your business owes to third parties and owners. To balance your books, the golden rule in accounting is that assets equal liabilities plus equity.
What is the main accounting equation?
The main accounting equation is: Assets = Liabilities + Equity. Together, they make up a company’s balance sheet.
The concept behind it is that everything the business has came from somewhere — either a third party, such as a lender, or an owner, such as a stockholder. Every dollar that a business holds is attributed to a third party or an owner.
This means that each thing a business has is classified as both an asset and a liability or an asset and equity. Here are two examples:
- An asset that is a liability: Your business has $10, but you borrowed it from George. The $10 is both an asset (cash) and a liability (a loan that you need to pay back).
- An asset that is equity: You invested $20 in your business buying equipment. The $20 is both an asset (equipment) and equity (owner’s equity that you should get back eventually).
What if your business generates money? Say your business earns a $5 profit that you put into a checking account. That profit is both an asset (cash) and equity (business profit held for future use). If your business collapsed tomorrow, the equity would be split between the owners.
What are examples of assets, liabilities, equity?
Here’s what assets, liabilities and equity may look like in a business.
An asset is anything that can be owned or controlled and generates — or will generate — an economic benefit.
- Liquid assets: Cash and cash equivalent
- Tangible assets: real estate like buildings and land; and business equipment such as machinery and vehicles
- Intangible assets: Patents, investments like stocks and bonds
- Noncurrent assets: accounts receivable, futures
A liability is a financial obligation. Debt is a type of liability and is generally the most dangerous type. They can be a vital part of a company’s operations, in both day-to-day business and long-term plans.
- Current liabilities: Anything due within a year including accounts payable, interest payable, short-term loans and taxes payable.
- Long-term liabilities: Anything due in more than a year, including bonds payable, notes payable, deferred tax and mortgages. These might also appear on your business debt schedule.
- Contingent liabilities: An obligation that might happen, depending on the occurrence or outcome of another event, such as a lawsuit.
Equity is the money value of an owner’s interest in property after liabilities are accounted for. Lenders and other third parties typically have first claim on company assets. Exactly how this value is calculated can differ. Market value is the current price, which investors look at to predict its future value. Book value is the past price, used for simply recording history.
- Equity capital: preferred stock, common stock and treasury stock
- Retained earnings
Other formulas for assets, liabilities, equity
Owner’s equity formula
The owner’s equity formula is the accounting equation switched around: Equity = Assets – Liabilities
Net change formula
Net change is the difference in the price of a financial product over time. For example, if a stock is worth $30 in January and $50 in March, the net change is $20. The net change formula is: Net Change = New Value – Old Value.
Frequently asked questions
What are the 3 elements of the accounting equation?
The three elements of the accounting equation are assets, liabilities and equity.
Why is the accounting equation important?
The accounting equation represents the main concept underpinning modern accounting systems.
What is shareholders’ equity in the accounting equation?
Shareholders equity in the accounting equation is included as part of the total equity value.