Companies measure their financial position by the basic accounting equation: Assets equal Liabilities plus Shareholders’ Equity. This is understood as the assets of a firm are purchased by borrowing money or with cash coming from the owners or shareholders. Any transaction taking place within a firm is represented on both sides of the equation. The accounting equation is represented on the balance sheet in more complex transactions.
Assets are things of value owned by a firm. Assets are classified in several categories, which include current assets, long-term assets, capital assets, investments and intangible assets. These assets were acquired by borrowing money from lenders, receiving cash injections from owners and shareholders or offering goods or services. Common current assets include cash and accounts receivable, while common long-term assets include notes receivable. Capital assets are items, such as plant, property and equipment. Investments are securities owned by a company, such as stocks and bonds. Common intangible assets found on a balance sheet include trademarks, goodwill, patents and copyrights. The accounting equation shows that the amount of assets must equal liabilities plus shareholders’ or owners’ equity.
Liabilities are obligations owed to other companies or people. Liabilities are categorized as current liabilities and long-term liabilities. Current liabilities are typically due within a year. Long-term liabilities are obligations that extend past a year. Common current liabilities your business may have on its balance sheet include accounts payable, wages payable and taxes payable. Long-term liabilities are typically owed to lending institutions, which include notes payable and possibly unearned revenue. Unearned revenue is considered a liability because you receive money for a service or product that you have not yet delivered.
Owners' equity is commonly called capital. It is debts or obligations owed to the owner. The owners of a public company are called shareholders. For example, if a company goes public, all money earned from the sale of initial stock is recorded as shareholders’ equity. Individuals who bought the company's stock now have a small ownership position within the company. An example of owners' equity is when an owner of a company invests $100,000 into the business for start-up cost. This transaction is recorded in the company's books as owners’ equity.
All transactions recorded as assets, liabilities or shareholders’ equity appear on the balance sheet, which is used by many businesses, accountants, owners and investors. The balance sheet gives a snapshot of a firm’s financial position at a specific point in time. The balance sheet is beneficial to potential investors because it shows a company’s resources and what it owes to others. Bankers and investors use the balance sheet to determine if a company is worthy of a loan.