Basic Accounting Equation

The basic accounting equation is Assets is equal to Liabilities plus Stockholders' equity. Of course, this can be rearranged to be Asset minus Liabilities is equal to Stockholders' equity and so forth. The importance of this equation cannot be overlooked, because the equation helps stakeholders of a company keep track of its financial health. The balance sheet illustrates this equation by listing assets on the top and liabilities and stockholders' equity on the bottom. The balance sheet is similar to a real estate appraisal in that both provide a report of financial condition on a specified date. The real estate appraisal, for example, is the value of a property on the date the appraisal was conducted. It does not matter if the house burned to the ground the next day, because the real estate appraisal is still accurate in its reporting. The same goes for the balance sheet. The drawbacks of simply using the balance sheet is that a balance sheet is only accurate the day it was prepared, and it does not provide the entire picture of a company's financial health. Therefore, the Retained earnings statement, statement of cash flows and income statement are also used in financial reporting. The Retained earnings statement relates to the income statement and balance sheet in that all three use some of the same information. For instance, the Retained earnings uses the net income calculated by the Income Statement. Furthermore, a company's retained earnings is also reported as stockholders' equity in the balance sheet.