Balance Sheet Equations – Ricky

The Balance Sheet Equation

 

There is one basic underlying grammar rule in writing a balance sheet, and that is the balance sheet equation. The balance sheet equation goes: Assets = Liabilities + Stockholder’s Equity. This means that the resources of a company is represented by the claim of resources by the owners of the companies and the outsiders. An apt example of this is housing mortgages. If I pay a part of the price of the house and leave a percentage of it as mortgage, the price that I paid becomes my, the owner’s, claim of the property, which is the house in this case, and the mortgage is the outsider’s claim of the resources.

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Now, since the key point of a balance sheet equation and the balance sheet is that they have to balance out in the end, a system called Double-Entry Bookkeeping is used to make sure of that. This means that if any part of the balance sheet equation is edited, the same edits have to be made on the other side of the equation, to make sure that the two parts balance out perfectly.

 

The Stockholder’s equity in the balance sheet equation can be expressed like this: Stockholder’s Equity = Contributed Capital + Retained Earnings. The contributed capital is the money that is raised from the shareholders of the firm, and the retained earnings is the money that is earned from operating the company. The retained earnings can be calculated with the following formula: Retained Earnings = Prior Retained Earnings + Net Income – Dividends. The Net Income, which is more commonly known, is Revenues – Expenses.

 

All put together, the complete Balance Sheet Equation looks like this: Assets = Liabilities + Contributed Capital + Prior Retained Earnings + Revenues – Expenses – Dividends. This equation can be used to calculate different changes in the balance sheet, using the rule that both sides of the equation have to balance out perfectly.

 

Image Source: http://i.investopedia.com/inv/articles/site/Corpfin2.jpg

 

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