Sign InBook a demo

What Is the Accounting Equation and Why Does It Matter?

May 02, 2020

“Accounting is the language of business.”

-Warren Buffet

There are several foundational concepts in accounting, that form the backbone of how an organization’s finances come together. These concepts have stood the test of time and are critical to creating a consistent and reliable view of an organization’s financials. As Warren Buffet famously said, when giving advice to an investment intern, “accounting is the language of business.”

Also, it’s important to note that when anyone is talking about accounting for organizations, you can generally assume they’re talking about double-entry accounting. This is the global standard.

Now you might know the first rule of double-entry accounting, debits must equal credits, those are the double entries. But when anyone refers to the accounting equation, this is what they mean:

The Accounting Equation (Assets = Liabilities + Equity)

There is so much packed into this simple equation. It is the inescapable balance that all companies must strive to achieve, that keeps them honest when there’s pressure to meet quarterly earnings, allocate costs, raise money, or do anything else that impacts their financials.

Essentially, here’s what each component of the equation represents:

  • Assets - Things like cash, land, furniture, equipment, and amounts owed to the company.
  • Liabilities - The company’s obligations to others, such as loans, and expenses incurred but not paid.
  • Equity - The remaining value retained by the owners after the two bullets above. As income accrues to the business, dividends are distributed, or losses are incurred, it all flows through equity.

So that’s it. It’s pretty simple at a high level. Although, as organizations grow and their operations become increasingly complex, it gets harder and harder to figure out how certain transactions should be recorded. Be wary of anyone who proposes an idea for how to improve financial results, but can’t explain how that idea fits into the equation above. It is the divining rod for numbers that don’t make sense.

Why You Need Financial Reporting Automation

The Power of Investment Management Software

Accounting Compliance and Controls: What To Know

Author
Recent Blogs
Ben Taylor
CEO & Co-Founder at SoftLedger

A CPA with more than 10 years of varied public and private accounting experience, Ben has led many complex financial projects to successful outcomes.

He began his career at Ernst & Young, followed by in-house management roles at Fannie Mae and other public companies.

Ben holds a B.S. in Accounting from the University of Maryland.

Leave a Reply

Your email address will not be published. Required fields are marked *

Frequently Asked Questions

Yes, users have the option to use their own chart of accounts or SoftLedger’s standard chart of accounts when getting started with SoftLedger.  SoftLedger’s flexibility allows users to make changes to their charts by easily adding new accounts.

Ready to Get Started?

Book a demo for a free test-drive of the SoftLedger software and APIs
Book a demo

Subscribe to our
newsletter

Read SoftLedger reviews on G2

© Copyright 2024 SoftLedger, Inc.

Features
Industries
Company
Blog
magnifiercross-circle