1. The Balance Sheet
A company needs financing to fund their operating activities. Liabilities + Equity identify the funding sources. Liabilities are funding from creditors and represent obligations of a company or alternatively, claims of creditors on assets.
Equity is the total of:
- funding invested or contributed by owners and
- accumulated earnings in excess of distributions to owners since the inception of the company.
The right side represents source of funds and left side represents use of funds.
Assets and liabilities are separated into current and non-current amounts.
Current Assets are expected to be converted into cash or used in operations within one year or the operating cycle (whichever is longer).
Current Liabilities are obligations of the company expected to settle within one year or the operating cycle (whichever is longer).
The difference between current assets and current liabilities is known as working capital. In other words:
The accounting equation can also be considered in terms of business activities:
However, operating activities can affect both sides of this equation. That is, if a company is profitable, both investing and financing levels increase.