As an entrepreneur who is thinking about starting a business or who is already running a business, you need to start learning the basics of accounting because you'll need to know them to report your business activities to the government when it's time to pay your taxes. Time is one of the most important ideas in accounting that you need to understand.
Accountants process data into documents called financial statements. The accounting equation is what the whole accounting system is based on.
So what is this magic formula?
The equation for accounting is:
ASSETS = LIABILITIES + OWNERS' EQUITY.
In crude definition,
ASSETS are things that a business owns that are worth money and are expected to make the business money in the future.
LIABILITIES are money that a business borrows from someone else or another organisation.
OWNERS' EQUITY is the amount of money that the business's owners have put into the business.
One way to think about this equation is that the left side is what the business has, like money, tools, a building, land, furniture, etc. On the right, you can see where these assets came from. Were they given by people outside the business, or did the people who own the business give them?
You might also see this equation written as:
ASSETS - LIABILITIES = OWNERS' EQUITY.
In other words, if the business's assets are enough to pay off all of its debts, you'll be left with a number that shows the owner's financial resources.
The idea of transposition in algebra is pretty much the same thing.
If you look at a business's BALANCE SHEET, or what is now called a STATEMENT OF FINANCIAL POSITION, you'll see that all of the items are set up according to either version of this accounting equation.
In a BALANCE SHEET, the numbers are written vertically, not horizontally like in an equation.
You'll see that the items are sort of like:
ASSETS XXX LIABILITIES YYY OWNERS EQUITY ZZZ
Where YYY + ZZZ = XXX.
So, the next time you see a balance sheet, also called a statement of financial position, think about this reasoning.
This article was written for OrangesAndLime.com to help creative people like artists, musicians, designers, illustrators, and entertainers start their own freelance businesses. Please keep in mind that this article is just a guide. Still, you should talk to a professional about it because laws and customs change over time and vary from one country to the next.
