The Accounting Equation
The Accounting Equation lies at the heart of everything in your business financials - all those reports you see (and maybe even ignore!) your profit and loss account and balance sheet, as well as your bookkeeping.
Understanding this principle is the unlock to getting clarity of your business numbers.
And yes, I know it sounds boring...but stick with me here!
In this video, you’ll learn one of the most critical principles in accounting and business finance and explain what it all means so you can understand it in your business.
The key basics behind the accounting equation is that overall - the value of things that the business owns added together equal all the value of things that the business owes
These amounts always have to equal each other - they always have to be the same - in accounting it is not possible for that not to happen.
This is a massively important part to remember the value of things the business owns is equal to the value of things the business owes
What are Assets, Liabilities and Equity?
Assets is the word that we use to describe the value of the things that the business owns
And the other side of that - the value of the things that the business owes - there are 2 words to describe that, depending on who the business owes that to. If the business owes it to the owner then it’s called equity, and if the business owes it to a 3rd party that is called liabilities.
So let’s say that you have received cash in the form of a £10k bank loan into your business.
The money, the £10k, is deposited into the company bank account - that money is now the businesses money - and it is an asset.
And the other part of that transaction is that you owe £10k now to the bank - that is an amount owed to a 3rd party and so is a liability.
And this is core too - that every transaction in your business will have 2 sides to it - this is the foundation for what is called double entry bookkeeping. Which there will be another video for on my channel and we’ll link to that in the notes.
But back to assets, liabilities and equity.
So in the instance I have described there is now the asset of cash £10k and the liability of the amount due to the bank the £10k - and as soon as the money is borrowed - they equal each other - so we can see the value of things the business owns is the same as the value of things the business owes.
What is the Accounting Equation?
Having explained that the value of things the business owns must equal the value things the business owes.
And we now know that the value of the things the business owes can be called liabilities or equity depending on who it is owed to - we can therefore put together the full accounting equation which is
Assets = liabilities + equity
Value of Things owned = Value of Things owed