What are assets, liabilities and equity?

Business owners should keep a finger on the pulse of three key components: their business assets, liabilities and equity. Knowing the total of each and ensuring that those numbers crunch as they should lays the foundation for good accounting. It can inform strategic business decisions and even prevent fraud.

To balance your books, the accounting equation says assets should always equal liabilities plus equity. But if you need a business loan or line of credit, understanding the relationship between assets, liability and equity is key. Taking out a loan means adding to your liability, and you need to be sure that it will still balance out in your company’s overall budget.

What are assets, liability and equity?

Assets are items that add to your company’s overall value. That could be cash, tangible assets like equipment or intangible ones like intellectual property. Liabilities are what you owe to others, like investors or banks that issue your company a loan. Equity is the amount left when you subtract liabilities from assets, and it represents the owner or owners’ stake.

When it comes to accounting, you need to make sure what you have in assets balances with your liabilities and owner equity. To do that, you use the accounting equation.

What is the accounting equation?

The accounting equation is:

assets = liabilities + equity

The accounting equation states that your business’s assets should always balance with its liabilities and equity. This equation forms the double entry accounting system, meaning that every transaction for your business will result in a double entry in your books.

Let’s say your company makes $20. This cash is an asset, but it’s also either a liability or equity. If Bank Y lent you that $20, it’s also a liability you need to pay back. You would enter this transaction as both an asset and a liability, keeping your books balanced.

Examples of assets, liabilities, equity

Let’s look at each individually to help you get a better feel for how all of this should break down at your company.

Assets

Assets are anything your company has to which you can attribute a positive dollar amount. That could be:

• Cash
• Company vehicles, equipment or real estate you own
• Inventory you have on hand
• Patents, copyrights and trademarks
• Investments
• Accounts receivable

In some instances, you might be able to quantify less tangible assets, like your company’s positive reputation in your community or an individual employee who has specific expertise.

How to calculate total assets

To some extent, calculating total assets is as simple as adding up everything of value your company owns.

If you don’t know the value of certain items, you may need to perform research or get in touch with an accountant who can value your assets. For example, if your company has a sizable social media following, you might use this calculator to arrive at a number to attribute to your asset.

To help you make the list of everything you should add together to arrive at total assets, think through:

• Liquid or near-liquid assets (cash, accounts receivable, inventory you could sell easily, etc.)
• Long-term assets (stocks, bonds, etc.)
• Tangible assets (equipment, real estate, vehicles, etc.)
• Intangible assets (company or employee reputation, etc.)

Liabilities

Liabilities represent financial obligations that your company has to other people or entities. That includes:

• Business loans (including interest and known fees)
• Accounts payable
• Equipment financing
• Real estate leases/mortgages
• Notes and bonds payable
• Dividends due to owners/shareholders
• Taxes (due in this tax year or deferred)

You should also include contingent liabilities or liabilities that might land in your company’s lap. This could include the cost of honoring product warranties or potential lawsuits.

Equity

Equity is the owners’ value in the company. That could be an individual owner — as with a sole proprietorship — or a large group, like shareholders in a publicly traded company.

You can think about equity in terms of what would happen if the company went bankrupt and liquidated its assets today. The company would need to pay back its liabilities. Then, the equity left would get distributed among the owners.

Owner’s equity formula

To calculate an owners’ equity, you total up a company’s assets and subtract its liabilities. In other words:

owner’s equity = assets – liabilities

For example, if a company with five equal-share owners has $1.2 million in assets but owes $485,000 on a term loan and $120,000 for a semi-truck it financed, bringing its liabilities to $605,000. Their equity would equal $595,000 ($1,200,000 – $605,000), or $119,000 per owner.

This usually differs slightly from the market value of the company. Specifically, it’s usually lower. That’s because market valuations often factor in aspects — from intellectual property to expected future returns — that you don’t include in the owner’s equity formula.

Net change formula

Most company’s assets, liabilities and equity aren’t fixed. You will need to periodically adjust your calculations to reflect the current values and debts you have. If you take out a new loan, for example, that added liability reduces owners’ equity.

If you know the initial accounting equation for your business, you can adjust the numbers based on the net change formula:

net change = current period’s value – previous period’s value

Let’s say your company had $7,000 in inventory last quarter but has $5,000 in inventory now. To find the net change, you subtract the previous period’s value ($7,000) from the current value ($5,000) to arrive at a net change of $2,000. That means you should have $2,000 less as you total your assets.

Bottom line

Assets, liabilities and equity are important factors that determine the health of your business. Before applying for a small business loan or line of credit, make sure your balance sheet is in order because lenders will look at it to see that you can repay your debt. To keep the books at your company balanced, your assets should always equal the combined total of your liabilities and owners’ equity.

Frequently asked questions

• What is an example of assets, liabilities and equity?

  An asset adds value to your business, whether cash, equipment, accounts receivable or something else to which you can attribute a dollar amount. A liability is something your company owes, from a loan to an outstanding invoice to a vendor. Equity is what’s left when you subtract liabilities from assets, symbolizing the owner’s value in the company.

• How do you identify assets, liabilities and equity?

  Assets represent the resources your business owns and that help generate revenue. Liabilities are considered the debt or financial obligations owed to other parties. Equity is the owner’s interest in the company. As a general rule, assets should equal liabilities plus equity.<br /><br />

  • Assets. Anything that you can attribute a dollar amount to that adds value to your business
  • Liabilities. The debt your company owes to other entities or individuals
  • Equity. The remaining amount when subtracting assets minus liabilities, which is owed to the owners

• How do you calculate assets, liabilities and equity?

  To calculate your assets, you’ll need to add up all resources and property your company owns, including intangible assets. Liabilities is the sum of all items payable to other parties, including vendors, lenders and shareholders. Equity is the value of the company when liabilities are subtracted from assets.