The accounting equation

One sentence that always holds

Assets = Owner's equity + Liabilities

In plain words: everything the business controls was financed from one of two places. Either the owner provided it, or an outsider did. There is no third source, so the two sides of the sentence can never drift apart.

This is called the accounting equation. It is not a rule someone invented to make bookkeeping tidy. It is a description of reality: a resource cannot appear in a business without someone having a claim to it.

Reading the equation three ways

The same relationship answers three different questions, depending on what you already know.

The middle line is the one used most often. It says the owner's claim is a residual: the owner gets what is left after outsiders have been paid, which is exactly why a business that borrows heavily can control large assets while the owner's claim stays small.

Applying it

Worked example. Sipho Dlamini runs a spaza shop in Mthatha. On 30 June the business records show:

Step 1. Total the assets: 12 400 + 31 600 + 86 000 + 4 000 = R134 000.

Step 2. Total the liabilities: 45 000 + 9 000 = R54 000.

Step 3. Owner's equity = assets - liabilities = 134 000 - 54 000 = R80 000.

So the business controls R134 000 of resources, outsiders can claim R54 000 of that value, and Sipho's claim is R80 000. Note that Sipho's R80 000 is not sitting in the bank. Equity is a claim on the business as a whole, not a pile of cash.

Core checkpoint: given any two of the three totals, you can find the third. Total the assets first, total the liabilities second, and only then work out the owner's claim.