The Most Important Concept in Accounting
ASSETS = LIABILITIES + OWNERS EQUITY
I remember this as one of the first things I learned in my accounting 101 course…
But it wasn’t until recently that I REALLY understood what this meant
Let’s start with a few definitions…
➡️ What are Assets?
Assets represent items of economic value that the business owns / has a right to.
These can be both physical (cash, machinery) and intangible (goodwill).
It can also represent a future right to cash, like Accounts Receivable
➡️ What are Liabilities?
Liabilities are what the company OWES, specifically with a capped amount
Examples can be :
Accounts Payable / Credit Cards (owed to vendors)
Line of credit (owed to creditors)
Deferred Revenue (owed to customers)
Accrued payroll (owed to employees)
➡️ What is Owners Equity?
Owners Equity represents the uncapped owners right to the business…IE the “Owners Equity”
This can be items that were personally invested by the owners (common stock / preferred stock / additional paid in capital)…
..and can also represent historical earnings of the business (Retained Earnings) that has yet to be paid out to the owners (typically in the form of dividends, but can also be an owners draw)
Here’s what recently clicked for me…
Liabilities & Owners Equity are in essence the same thing
The difference is that Liabilities are CAPPED —> they are owed at a specific amount
While Owners equity is UNCAPPED —> it is owed at an amount with no limit
The sum of both of these items are what contributed to your assets…
Put another way, your assets came into existence by either:
💰 Amounts contributed by creditors / customers / employees (IE expenses not yet paid out to employees)
💰 Amounts contributed by owners (which include historical profits)