The basic accounting equation is:
It shows that everything a company owns is financed either by creditors or by owners.
Components
- Assets: resources the company controls, such as cash, inventory, and equipment
- Liabilities: obligations, such as loans or Accounts Payable
- Equity: the residual claim after liabilities are subtracted
Rearranged form:
Why it matters
- Every transaction affects the equation.
- The equation is the foundation of the Balance Sheet.
- Profit ultimately flows into equity, which connects it to the Income Statement.
Simple examples
- Borrow cash: assets up, liabilities up
- Buy equipment with cash: one asset up, one asset down
- Earn revenue in cash: assets up, equity up
- Pay a supplier: assets down, liabilities down