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Overview

Have you ever looked at your company’s financial statements and thought they were written in a foreign language? If there was an English-Accounting dictionary, maybe more people would understand the information.

Accounting is the most important information in business. It records, analyzes, plans and controls all your transactions. If you understand accounting basics, then you will know how healthy your business is and where you can save or spend more money to help it grow.

In this article, we learn how to figure out Google’s profits and equity in your home.

Big Idea #1: A basic accounting equation measures a company’s financial position using assets, liabilities and owner’s equity.

Accounting can seem like a complex process, but it’s actually pretty simple. It follows a logical order and you just need to know how to figure it out.

Let’s get started with the basics. An accounting equation measures financial position using assets, liabilities and owner’s equity. Here is a refresher on what those terms mean: Assets = everything a company owns, such as properties, inventory and cash Liabilities = all the company’s debts Owner’s Equity (also called Shareholder’s Equity) = difference between assets and liabilities

The accounting equation says that assets equal liabilities plus owner’s equity. You can also write the equation like this: assets minus liabilities equals owner’s equity.

This equation applies to any business, regardless of size. Imagine you run a lemonade stand. Your assets are: the stand, cups and uniforms (worth $100 in total). You borrowed $60 from your sister and mom – those represent your liabilities. So here’s how we would determine owner’s equity: Assets ($100) – Liabilities ($60) = Owner’s Equity ($40).

If you wanted to buy a house for $300,000, you wouldn’t pay the full amount. You’d get a mortgage for $230,000. In that case, your equity would be:

“”$300,000 assets – $230,00 liabilities = $70,000 equity.”

And a few years down the road, once you’ve paid off $30,000 of your mortgage, your home equity would be equal to $300,000 assets minus $200,000 liabilities. One thing to remember about assets and liabilities is that they can be reciprocal. For instance, in the scenario above where you have a mortgage debt of $200K on your house worth $300K fully paid up after 30 years with monthly payments at 6%, the bank has an asset (your loan) and you have a liability (the debt).

Big Idea #2: The accounting equation forms the basis of your balance sheet.

We’ve learned that the accounting equation is fundamental. It’s also important for another reason, which is that it forms the basis of your balance sheet.

A balance sheet is an important financial statement. It uses assets, liabilities, and owner’s equity to show how a firm stands financially at any given point in time.

The assets of a business are the things that it owns, such as cash, inventory and property. For our lemonade stand, this would include our checking/savings accounts; soon-to-mature investments like the investment in the lemon farm; our lemons for making the lemonade; Mr. Johnson’s payment for catering last week’s party with his order of lemonade; The actual stand itself and your pitcher and strainer.

Liabilities are accounts payable and notes payable. The grocery store is owed $100 for 100 lemons, and we owe our sister a loan of $15. Common stock and retained earnings are owner’s equity. We have saved up $15 to open the stand, plus the sum of all income that hasn’t been distributed as dividends yet.

As a result, our balance sheet would look like this: Assets: Cash ($15)