The balance sheet can be dividend into 3 parts and these 3 parts are assets, liabilities and equity. So what are these items ? Assets are anything of value, liabilities are debts while equity is the portion of the assets that belongs to the shareholders. These 3 items are related by the following equation.
Assets = Liabilities + EquitySo what is the rationale behind this equation ? Let me explain using an example below.
You wish to buy a car that has a value of $50,000. However, you only have $20,000. Thus you decide to go to a bank to take a loan of $30,000. As a result, you are able to purchase the car. In this case, you took on a loan of $30,000 thus you will have a liability of $30,000 while the other $20,000 came from your pocket, so this $20,000 will be your equity. In all, you will own a car that has a value of $50,000 thus you will have an asset of $50,000.Similarly, the stockholders of a company contributes capital to a company and the company may take on additional debts to fund the purchase of assets which can help the company to increase its earnings. I have grouped the assets, liabilities and equity with coloured rectangular boxes on M1's balance sheet. The blue stands for the assets, red stands for the liabilites and the green one stands for the equity. In my next post, I will be discussing on what each individual item on the balance sheet stands for.
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