Financial Accounting is a standard methodology for people and businesses to account for their financial situation.
Financial Accounting is usually used to discuss businesses, but it could equally be applied to a person or a family. At ULearnMoney.com we recommend that you think of your financial situation in the same way a business does.
Financial Accounting is too broad a topic and concept to cover in a quick reference, but all financial accounting starts from the equation:
A = L + OE
Assets = Liabilities + Owners Equity (sometimes called ‘Proprietorship’)
On first reading this equation might not make intuitive sense, but to help you grasp the underlying principles think of how this equation might relate to your own personal circumstances:
Your ‘Assets‘ are anything of financial value that you own. If you borrow money from your parents or you spend money on your credit card, your liabilities (or your debts) go up but your assets also go up because you now either have more money (that you got from your parents) or you own the thing that you bought on your credit card. So your assets have gone up and your liabilities have gone up.
If you earn money by doing a job, or from an investment, you have generated money on your own, so your assets have gone up and your ‘Owners Equity‘ have also gone up.
The equation A = L + OE reflects the layout of the first of the three financial accounting reports which are widely used to illustrate a person or business entities financial position. These three reports are:
- Balance Sheet (or Statement of Financial Position)
- Profit and Loss Statement (P & L) (or Statement of Financial Performance)
- Cashflow Statement
Your own personal balance sheet might look something like this:
Cash on hand (in your wallet) $40
Cash in the Bank $300
Bike (value at purchase) $500
Other Doo Dads (iPhone etc) $4000
Car (value at purchase) $10,000
TOTAL ASSETS $10,840
Car Loan $9000
Credit Card Debt $700
TOTAL LIABILITIES $9,700
Cash Capital (from your job) $940
Gift from your parents $200
TOTAL OWNERS EQUITY $1140
NOTE: Assets – Liabilities – Owners Equity = $0 which is the same as saying:
Assets = Liabilities + Owners Equity