How To Calculate and Use The Basic Accounting Equation (With Examples)

Managing your business’s finances and revenues can be a full-time job, so you may need to create a financial position to handle these duties within your small business.

However, many small businesses—especially new small businesses —prefer to handle this aspect of their businesses themselves, foregoing the help of an accountant to manage the company’s balance sheet and business transactions.

If you’re a small business owner who would prefer to monitor your company’s cash flow with your own two eyes, there are financial accounting equations that you should be familiar with. These fundamental accounting equations are rather broad, meaning they can apply to a wide array of businesses. Combined with an understanding of accounting basics for small businesses, the accounting formulas will provide you with the figures you need to understand your business’s viability and health to make more informed business decisions.

Below, we’ll cover the fundamentals of the accounting equation and the top business formulas businesses should know. Read end-to-end for a fuller understanding of accounting formulas or use the list to jump to an accounting equation of your choice.

The ACCOUNTING EQUATION For BEGINNERS

When to use asset = liabilities + equity

The basic accounting equation is used by companies of all sizes to understand exactly how much the total sum of their assets is worth at a certain point in time and how much they owe to other parties, with the difference between the two being an accurate representation of a companys overall financial status.

It is also used to keep track of any investments made by the company and to make sure all transactions are properly recorded, as the double-entry system should produce equal credit and debit columns. Properly assessing the companys financial health can help shareholders keep track of all the money going in and out, helping them make more informed financial decisions without the risk of overlooking any crucial factor, such as diminishing income or growing debt.

The basic accounting equation is not a complete and accurate representation of a companys performance. It is, however, a tool that can be used to interpret the companys situation and conceive a long-term strategy based on the companys assets, liabilities, outstanding loans and other sources of income and expense.

What is asset = liabilities + equity?

Asset = liabilities + equity is the basic accounting equation and the main element of the double-entry accounting system. The double-entry system records transactions as debits and credits. Given the fact that each debit offsets a credit, the sum of all debits needs to be equal to the sum of all credits in any accurate double-entry system. The accounting equation is a tool used to make sure that the balance sheet maintains the equilibrium between the debit side and the credit side.

Any organization, irrespective of its size, uses two main balance sheet components: assets and liabilities. The third and final component of the basic accounting equation is the shareholders equity, which represents the owners total ownership of the company after all debts have been paid off. The basic accounting equation represents how these three elements that define an organizations financial status are related to each other.

What is included in asset = liabilities + equity

The main elements of the basic accounting equation are:

Assets

Assets are all valuable belongings of a company, such as land, buildings, equipment and intellectual property. Based on their exact nature, they can be divided into different asset types:

There are usually two asset categories:

Liabilities

Liabilities are all the companys debts, such as unpaid bills, mortgages, bank loans and generally any sum of money that the company owes another party. Some of the most widely encountered liabilities are:

There are usually two liability categories:

Equity

How to use asset = liabilities + equity

These are generally the main steps for calculating the basic accounting equation:

Example of asset = liabilities + equity on a balance sheet

This is an example of the basic accounting equation on a balance sheet:

FAQ

What equations are used in accounting?

The three elements of the accounting equation are assets, liabilities, and shareholders’ equity. The formula is straightforward: A company’s total assets are equal to its liabilities plus its shareholders’ equity.

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