Wait, before you read on any further, have you read about Assets, Liabilities and Equity? If you haven’t, this post won’t make much sense – so go and read them first then come back!
When you put the good, the bad and the ugly together, you get something beautiful which is known as a “balance sheet,” (no, not a spaghetti western!). A balance sheet may be called something else depending on where you are from, but the concept is the same – it is an overview of the assets, liabilities and equity that a business has.
In any balance sheet, the one unbreakable rule is that:
Assets = Liabilities + Equity
Note that the equation given above can sometimes be presented as Net Assets which is:
Assets – Liabilities = Equity = Net Assets
Which really is the same thing (because: Algebra!!)
Your Assets are always equal to the amount of Liabilities and Equity you have in the business simply because Equity and Liabilities are used to purchase Assets. So, if you took out a $1,000 loan to buy a Van for the business, you have a $1,000 van in your assets and a $1,000 loan in your liabilities. If you raised $2,000 in shares to bring cash into the business, your equity goes up by $2,000 and your cash balance in your bank goes up by $2,000 as well.
The point I’m trying to make is that Assets, Liabilities and Equity are all important aspects of your business and that it is difficult to run a business without one or the other. Some businesses do run purely with Assets and Liabilities or Assets and Equity – but these are often the exception to the rule. There are pros and cons to using liabilities and equity and its up to you as the business owner to decide what is appropriate for your business at any time. Most small businesses start off using equity to get their business off the ground and as they grow larger, they may start taking loans to finance their business and when they get even larger, they may issue more shares to further expand the business.
Now that you know what Assets, Liabilities and Equity are, you are well-positioned to learn about two things that affect your Assets, Liabilities and Equity – these are known as Income and Expenses!