Next, we’re going to take a quick look at the second main financial statement, the balance sheet.
The balance sheet shows which ASSETS the company owns, the LIABILITIES it owes to others, and the EQUITY that belongs to the owners.
Assets are usually things of value, or resources the company owns and uses.
For instance, land and buildings, office equipment, inventory, or cash, just to name a few.
Liabilities are what you owe to others.
For example, a bank loan, or what you owe to your suppliers for goods, or to the IRS in taxes.
The third component is equity.
This is a bit more abstract.
It’s the residual amount that would be left if the company sold all its assets and paid off all its liabilities.
In other words, it’s the difference between total assets and total liabilities.
This leftover money belongs to the owners of the company.
In the balance sheet, the assets are on one side, and equity and liabilities are on the other side.
If you draw a line between the two, and one on top, it looks like a T.
This is what accountants use to visualize accounting transactions.
It’s a very helpful tool, and we’re going to come back to these T accounts all the time.
You can see that the left side of the T is just as big as the right side.
That’s because everything the company owns, its assets, was purchased either from debt, so somebody else’s money, or its own money, meaning equity.
For money to go to one account, it must come out of another.
We call this a flow of economic benefit from a source to a destination.
We already said that assets minus liabilities equals equity.
If we rearrange this, like this, we get assets equal liabilities plus equity.
Both sides are always in balance, hence the name balance sheet.
And that is the foundation for any accounting system; the accounting equation.
The total amount of assets equals total liabilities plus equity.
Both sides are in balance.