Accounting is not a Mystery: Short Version
Imagine that you own a business that you are looking at it from across the street one morning before it opens for business. Ask yourself, "What is it that this business has? The answer will start with the things you can see:
Inventory (also called "Stock in Trade")
You also know that the business has
- checking account(s)
- savings account(s)
- cash for making change
All of these things that the business has are called its "Assets."
LIABILITIES & CAPITAL
The business may have these Assets, but it does not own them. Instead it owes the Assets to:
The banks and other creditors and
Amounts owed to the banks and other creditors are called the business' "Liabilities."
Any amount left over after subtracting the Liabilities from the Assets is called the "Capital." To make the meaning clearer, it is also called "Owner's Equity."The obvious formula is:
ASSETS - LIABILITIES = CAPITAL
ASSETS = LIABILITIES + CAPITAL
Now imagine that in is the end of the day. You know that during the day sales were $1,000 but of that amount, expenses of $400 were paid. So the amount of profit remaining at the end of the day is $600. The business has the $600 by depositing it in the checking account but the business naturally owes the same money to the owner.
Both sides of the equation go up by $600:
(Assets + $600) = Liabilities + (Capital + $600)