Assets, Liabilities, Equity: An Overview for Small Businesses

Assets, liabilities, and equity are the three account types on your business’ balance sheet. Every account on your balance sheet is either:

• An asset – something that your business owns, such as cash, machinery, or receivables
• A liability – something that your business owes, such as loans, payables, or credit card balances
• Equity – something that represents your ownership in the business

In fact, your business’ balance sheet is called a balance sheet because it has to “balance” according to the fundamental accounting equation formula: assets = liabilities + equity.  This means that the sum of all your business’ asset accounts must equal the sum of all your business’ liability accounts, plus the sum of all your business’ equity accounts.

Assets = liabilities + equity

This accounting equation only makes sense if you understand that every transaction has to be recorded on your books twice.

Confused? Let’s work through an example. Let’s say that you start a new business and contribute $10,000 to your company.

While it’s intuitive that this transaction would increase your business’ cash account by $10,000—and it would—the other “side” of this transaction is a credit to the owner’s investment account for $10,000. In this way, the $10,000 deposit is recorded on your books twice, and at this moment in time, your balance sheet looks like this:

Assets

Cash and Cash Equivalents $10,000
Total Assets $10,000

Equity

Owner’s Investment $10,000
Total Equity $10,000

You can see that the accounting equation formula holds true: your business’ assets of $10,000 equals its equity of $10,000.

Now, what if you take out a loan for an additional $5,000 in cash? In this case, both your cash account and your loan payable account—a liability—would increase by this $5,000, so your balance sheet would look like this:

Assets

Cash and Cash Equivalents $15,000
Total Assets $15,000

Liabilities

Loan Payable   $5,000
Total Liabilities   $5,000

Equity

Owner’s Investment $10,000
Total Equity $10,000

Once again, the accounting equation formula balances: your business’ assets of $15,000 equals the sum of its liabilities of $5,000 and its equity of $10,000.

What about income and expense accounts? These accounts eventually become part of your business’ retained earnings account, which is an equity account.

Helpful Tip: If you use a professional bookkeeping software, your software will automatically adjust the appropriate accounts whenever a transaction is recorded, as long as you categorize the transaction correctly. Of course, when closing the books for a given period, you must still check your books for accuracy and record any transactions that weren’t captured by your software.

Assets and liabilities examples.

Here are common examples of asset accounts:

• Cash – Fairly self-explanatory, your cash account is the amount of cash your business has in business bank accounts or on hand.
• Accounts receivable – Accounts receivable represents the amount of money you expect to be paid by clients or customers for work your business has already performed or goods your business has already delivered.
• Inventory – Your inventory account represents the total cost to acquire or produce goods you intend to sell to your customers.
• Property, plant, and equipment (PP&E) – This account is for all the tangible assets that you need to run your business. For example, if you own a manufacturing business, your PP&E account might include the factory buildings your company owns, as well as the production machinery within them.
• Accumulated depreciation – Accumulated depreciation is technically a contra-asset account that appears below your property, plant, and equipment account on your balance sheet. It represents the sum of the historical depreciation expense you have recorded on these assets.

Sometimes, a balance sheet will reflect two subcategories of assets: current assets and non-current assets.

Current assets are generally assets that are cash, a cash equivalent, or any other asset that is expected to be converted to cash within the next year, such as inventory or accounts receivable.  Non-current assets are assets other than current assets.

Here are common examples of liability accounts:

• Accounts payable – Accounts payable represents the amount of money you are obligated to pay your vendors for work they have already delivered or goods they have already delivered.
• Accrued wages – The accrued wages account is for wages earned by your employees that you have not yet paid them.
• Deferred revenue – Deferred revenue is an account used to record cash that has been received by your business for services it has not yet performed or goods it has not yet delivered.
• Loans payable – This account is for loans taken out by your business.

Similar to assets, liabilities can also be grouped into current and non-current depending on when you expect to have to pay off the liability in full.

_{Information provided on this blog is for educational purposes only, and is not intended to be business, legal, tax, or accounting advice. The views and opinions expressed in this blog are those of the authors and do not necessarily reflect the official policy or position of Lendio. While Lendio strives to keep its content up-to-date, it is only accurate as of the date posted. Offers or trends may expire, or may no longer be relevant.}