Lesson #5 - The Third Element - EQUITY (and the ACCOUNTING EQUATION)

Definition:
EQUITY is the residual interest in the ASSETS of the business after deducting all the LIABILITIES.

Just like Einstein introduced us to the famous equation E=mc2...

Who you lookin' at?

...accounting has an equation too and it is...

EQUITY = ASSETS - LIABILITIES

When you spin it around, the following equation is also true...

ASSETS = LIABILITIES + EQUITY

REMEMBER THIS EQUATION!!!

Equity is like your "net worth" i.e. add up all the ASSETS you own, then subtract from that all the LIABILITIES that you owe.

Examples:
1. Share capital
Capital that is contributed by yourself to start-up a business. This is usually in the form of cash but can be in the form of fixed assets as well.

2. Retained profits or reserves
When your business makes a profit, that profit is "retained" and "channelled back" into the business, accumulated and brought forward to the future. This INCREASES your EQUITY.

On the other hand, when your business makes a loss, that loss is "taken out" from the business and deducted from your equity. This DECREASES your EQUITY.

The nature of Equity:
EQUITY is CREDIT in nature.

When EQUITY gets BIGGER or INCREASES, it will head in a CREDIT direction, as that's in line with its nature. Conversely, when EQUITY gets SMALLER or DECREASES, it will head in a DEBIT direction.

In Conclusion:
As EQUITY is what's left over from your ASSETS after deducting your LIABILITIES, and it introduces us to the Accounting Equation, let's listen to a cheesy song, that has another "equation" in it.

Here it is! "Me - You = Blue" by Glenn Medeiros.

Enjoy!!!