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Yasser Sadek

  • 2018-11-07 07:43:37

The Balance Sheet Equation The balance sheet is so named because the two sides of the balance sheet ALWAYS add up to the same amount. The balance sheet is separated with assets on one side and liabilities and owner’s equity on the other. This one unbreakable balance sheet formula is always, always true: Assets = Liabilities + Owner’s Equity. At first, this rule can be really confusing. But think of it this way. All the assets owned by a business fall into one of two categories. They’re either owned by a creditor (you had to take a loan to get them) or they’re owned by you (you paid for them in full). That’s pretty much all the balance sheet equation is saying! Let’s use a simple balance sheet example that you’re probably familiar with – a home mortgage. Assume you recently purchased a home worth $250,000. With the financial carnage of 2008 fresh in your mind, you put down a healthy 20% down payment of $50,000 and took out a loan for the remainder of the balance of $200,000. What would your balance sheet look like in terms of assets, owner’s equity and liabilities? The asset column would be the value of the home, regardless of who owns it. So in this case, the value of the home is $250,000. Assets = $250,000. Our liabilities – the amount we owe to someone else – is the value of the loan. This is what we’re financially obligated to pay to someone else. So liabilities = $200,000. Let’s go back to our universal balance sheet formula: Assets = Liabilities + Owner’s Equity Inserting our values, we get: $250,000 (Assets) = $200,000 (Liabilities) + Owner’s Equity At this point, you can compute owner’s equity one of two ways. You can either do some simple algebra and solve for the equity figure. Or you can go back and recognize that we put down $50,000 of our own money. So that would be the portion of the home we own and which represents the owner’s equity. $250,000 (Assets) = $200,000 (Liabilities) + $50,000 (Equity) You’ve probably done this in your head before and never realized it was an accounting balance sheet at work!

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