You’ve probably heard the terms asset, liability, and equity thrown around, but if you don’t know what they are, you might not understand how they affect your business.
In this article, I am going to go over the basics of what they are and how each of those terms is crucial when you’re considering your business finances.
The Balance Sheet
The balance sheet shows how a business is performing financially, and it breaks down a few types of the company’s accounts. In bookkeeping, an account is a record of financial transactions that pertain to a particular asset, liability, equity, revenue, or expense account. Balance sheets contain three types- assets, liabilities, and equity.
1. Asset Accounts
Asset accounts are accounts that represent the things that the business owns. If you’ve ever heard the term “net worth” before, you’re already familiar with asset accounts.
Net worth just means the total value of your assets, minus the total value of your liabilities. To give you an example, let’s say that your business has $20,000 in assets, and it owes $5,000. That means that your net worth is $15,000.
Assets can be physical assets (referred to as “fixed assets” in the books), like a computer or a car, or they can be intangible assets, like your patents or copyrights. The most important thing to remember about assets is that they’re valuable to your business, and they have a monetary value.
2. Liability Accounts
A liability is a financial obligation. If a business owes someone money, then that money is a liability. For example, if you have a credit card with $5,000 worth of charges on it, you have a liability of $5,000.
Liability accounts are used to track debt. For example, if you borrow money from a bank, you can use a liability account to keep track of how much you owe at any given time.
3. Equity Accounts
Equity is the amount of your business that belongs to you. Equity accounts are accounts that are used to track the value of your business’s equity. For example, if you own a business with no debts, and you have a cash value of $500,000, you would have an equity value of $500,000.
Some commonly-used equity accounts include money you put into the business or take out of the business, otherwise known as draws or investments. How these accounts behave is very similar across business types, but may differ slightly depending on the entity. When you invest money into your business, you increase your equity in the business. When you withdraw month from your business, you decrease your equity in the business.
If you have a question about any of the accounts mentioned above, or you want to talk to me about using them in your business, don’t hesitate to reach out: I’m happy to help!