Assets = Liabilities + Owners' Equity
This equation is also the framework for keeping track of money as it flows in and out of your company. Starting with the first penny you earn, you'll record in a general ledger each and every transaction using a double-entry system of debits and credits. Assets get recorded on the top or the left side of the balance sheet; liabilities and owners' equity are recorded on the bottom or the right side of the balance sheet.
The information on each company's general ledger is unique to that business; however, all companies classify their general ledger accounts as assets, liabilities or owners' equity. Businesses use more specific accounts within each classification, for example, "current assets" or "long-term liabilities," to organize and track their finances.
An asset is anything of value that your company owns — including cash. Assets get recorded on the balance sheet in terms of their dollar values. Remember, even if you used credit to purchase an asset, you still own it. Its full dollar value gets recorded on one side of the balance sheet as an asset, and the amount you owe gets recorded on the other side of the balance sheet as a liability. There are several types of assets:
- Current assets. These are assets with dollar amounts that continually change, for example, cash, accounts receivable, inventory or raw materials your company uses to make a product. They are listed on the balance sheet in order of their liquidity, or how fast they can be converted into cash.
- Investments. Companies, like individuals, can own securities such as stocks and bonds. Investments, like cash or property, are considered assets.
- Capital assets. Think of capital assets, also called plant assets, as permanent things your company owns. Land, buildings, equipment and vehicles are common capital assets. So are things like computers, furniture and appliances, as long as they remain for use within your business and are not items you sell.
- Intangible assets. Patents, copyrights and other nonmaterial assets that have value are referred to as intangible.
Anything a company owes to people or businesses other than its owners is considered a liability. There are two types of liabilities:
- Current liabilities. In general, if a liability must be paid within a year, it is considered current. This includes bills, money you owe to your vendors and suppliers, employee payroll and short-term loans.
- Long-term liabilities. A long-term liability is any debt that extends beyond one year, such as a mortgage.
Owners' equity, also called capital, is any debt owed to the business owners. For example, if you invested $50,000 of your savings to start a business, that amount is recorded in a capital account, also referred to as an owners'-equity account. In publicly traded companies, outstanding preferred and common stock also represents owners' equity.
Your business's revenues and expenses are also recorded in capital accounts because they relate to how much money your company makes over a period of time. At the end of each accounting cycle, a business' profits get transferred to a capital account.