Unit 12 · Lesson 2 Accounting

The year is over. What's the business worth today?

The story so far Your income statement said the shop earned $2,800 this year. The bank liked that, but it asked a second question: "What does the business have right now, and what does it owe?" On December 31 the shop has $2,600 in the bank, a customer who owes it $1,000, parts on the shelf, and the tool kit. It also owes a parts supplier and still owes $2,000 on its loan. Answering the bank takes the second financial statement: the balance sheet.

What

A balance sheet lists what a business owns, what it owes, and what's left for the owners, on one exact day.

Why

Profit tells you how a year went. The balance sheet tells you how strong the business is right now: can it pay its bills, and how much does it lean on debt?

How

List the assets, list the liabilities, and the difference is equity. The two sides always match.

Who

Accountants and auditors make sure it adds up. Credit analysts and commercial lenders read it before every loan. Private equity and investment bankers dig through it before buying a company.

What you're looking at: the shop's balance sheet as a scale. On the left, everything it owns: $7,000. On the right, who has a claim on those things: lenders and suppliers are owed $3,000, and the other $4,000 belongs to you, the owner. The scale is always level.

01 See it

Owns, owes, and what's yours.

The income statement is a video of a whole year. The balance sheet is a photo of one day. It has three parts, and they always fit one equation.

Assets

Assets are everything the business owns that's worth something. Current assets turn into cash within a year: cash, accounts receivable from Lesson 11.2, and inventory. Long-term assets, like equipment, last for years.

In this example

Current assets: Cash $2,600 + receivable $1,000 + parts inventory $1,000 = $4,600.
Long-term asset: The tool kit, worth $2,400 on the books (see below).
Total assets: $4,600 + $2,400 = $7,000.

Book value and accumulated depreciation

Remember the $3,000 tool kit and its $600 a year of depreciation from Lesson 12.1? The balance sheet keeps a running total of all the depreciation so far, called accumulated depreciation. Price minus accumulated depreciation is the asset's book value.

Book value = price − accumulated depreciation

In this example

After 1 year: $3,000 − $600 = $2,400.
After 3 years: $3,000 − 3 × $600 = $1,200.

Liabilities

Liabilities are everything the business owes. Current liabilities are due within a year, like accounts payable. Long-term liabilities, like most of a loan, are due later.

In this example

Current: Accounts payable to the parts supplier: $1,000.
Long-term: The equipment loan: $2,000.
Total liabilities: $1,000 + $2,000 = $3,000.

Equity

Equity is what's left for the owners: assets minus liabilities. It has two pieces: the money owners put in, and retained earnings, the profit the business has earned and kept. For a person, the same idea is called net worth.

In this example

Money you put in: $1,200 of your savings, when you opened the shop.
Retained earnings: This year's net income, all kept in the business: $2,800.
Total equity: $1,200 + $2,800 = $4,000.

The accounting equation

Everything a business owns was paid for by someone: lenders or owners. So the two sides always match. That's the accounting equation, and it's why it's called a balance sheet. Every transaction changes at least two things, so it stays balanced.

Assets = liabilities + equity

In this example

Check: $7,000 = $3,000 + $4,000. It balances.

Make something happen, and watch both sides move

What you're looking at: the shop's balance sheet on December 31, starting at $7,000 = $3,000 + $4,000. The left bar is assets, split into cash, receivables, inventory and equipment. The right bar is liabilities (orange) and equity (blue). Each button is a real transaction; both bars always end up the same height.

Can it pay its bills?

Working capital is current assets minus current liabilities. The current ratio divides them instead. Lenders like to see a current ratio above 1, often 1.5 or more.

Current ratio = current assetscurrent liabilities

In this example

Working capital: $4,600 − $1,000 = $3,600.
Current ratio: $4,600$1,000 = 4.6. Plenty of cushion.

How much does it lean on debt?

The debt-to-equity ratio compares what the business owes to what the owners have in it. Higher means more borrowed money: bigger returns in good years, bigger danger in bad ones.

Debt-to-equity = total liabilitiesequity

In this example

The shop: $3,000$4,000 = 0.75: 75 cents of debt for every dollar of yours.

02 Hear it

Two minutes. Just listen.

Tap any line to jump to it.

03 Play it

Keep it balanced.

Eight balance sheet questions from small businesses. Each one gives you the numbers. One try each.

Question 1 of 8

Right0 of 0

What you're looking at: made-up businesses. Each lists a few balance sheet numbers, then asks one question.

04 Break it down

The logic, step by step.

To read any balance sheet, run these three steps.

Step 1: Check that it balances

Assets = liabilities + equity

In this example

The shop: $7,000 = $3,000 + $4,000.

Step 2: Can it pay the next year's bills?

Current ratio = current assetscurrent liabilities

In this example

The shop: $4,600$1,000 = 4.6.

Step 3: How much is borrowed?

Debt-to-equity = total liabilitiesequity

In this example

The shop: $3,000$4,000 = 0.75.

Worked example: one transaction, step by step

What happens. You buy a $1,000 parts washer and pay cash.
Assets. Cash goes down $1,000. Equipment goes up $1,000. Total assets stay $7,000.
Liabilities and equity. Nothing changes: $3,000 + $4,000.
Still balanced. $7,000 = $3,000 + $4,000. You swapped one asset for another.
But look closer. Current assets fell to $3,600, so the current ratio drops from 4.6 to $3,600$1,000 = 3.6. Same total, less cash on hand.

05 Nature link

Counting a herd from the sky.

To count the wildebeest of the Serengeti, scientists fly over the plains and take photos, then count the animals in them. That photo shows the herd on one day. Births, deaths and migration over the year are a different question, tracked a different way.

What you're looking at: an illustration, not data. On the left, wildebeest seen from a plane, inside a camera frame: one moment. On the right, a calendar: a whole year.

Why this sticks. The herd count tells you how big the herd is today. It doesn't tell you if this was a good year for calves. A balance sheet is the same: a snapshot of what a business has right now, not how it got there.

06 Notes

The page you'd copy down.

Balance sheet: a snapshot on one day. Assets = liabilities + equity. $7,000 = $3,000 + $4,000.
Current assets (cash, receivables, inventory): $2,600 + $1,000 + $1,000 = $4,600.
Book value = price − accumulated depreciation. $3,000 − $600 = $2,400.
Liabilities: payable $1,000 (current) + loan $2,000 (long-term) = $3,000.
Equity = money put in + retained earnings. $1,200 + $2,800 = $4,000.
Current ratio = $4,600$1,000 = 4.6. Debt-to-equity = $3,000$4,000 = 0.75.

Fill in the blanks

1. Assets = liabilities + .

2. Profit a business has earned and kept is called retained .

3. With $60,000 of current assets and $30,000 of current liabilities, the current ratio is .

4. A $5,000 machine with $2,000 of accumulated depreciation has a book value of dollars.

07 Together

Grab a friend or a study group.

Two-sided story

One person names a transaction ("the shop buys a van with a loan"). The other says which two lines change and by how much.

Read a real one

Look up a public company's balance sheet. Check that assets equal liabilities plus equity. Work out its current ratio and debt-to-equity.

Button challenge

Using the buttons above, which transactions change the total? Which only swap one asset for another?

08 On your own

Just you and your money.

These stay on this device. Nobody else sees them.

Make your own balance sheet: list what you own and what you owe. What's your net worth?

Which of your assets could you turn into cash within a year? Which couldn't you?

What's one move that would grow your equity this year: earning, saving or paying down debt?

09 Check

Exam-style questions.

Written the way a college exam would ask them. Each right answer on the first try is worth 10 xp.

On the job: you're a commercial lender

A bakery asks your bank for a new $30,000 loan to buy a second oven. Here's its balance sheet today:

Current assets: cash $20,000, receivables $5,000, inventory $15,000.
Long-term assets: equipment with a book value of $60,000.
Current liabilities: $20,000 of bills due this year.
Long-term liabilities: a $40,000 loan.
Your bank's rule: debt-to-equity must stay at 2 or below.

Your task: find total assets, total liabilities and equity. Work out the current ratio and debt-to-equity. Does the $30,000 loan fit the bank's rule? If not, what could the bakery do?

See a model answer

Totals: assets $20,000 + $5,000 + $15,000 + $60,000 = $100,000. Liabilities $20,000 + $40,000 = $60,000. Equity $100,000 − $60,000 = $40,000.

Current ratio: $40,000$20,000 = 2.0. Healthy.

Debt-to-equity today: $60,000$40,000 = 1.5.

With the new loan: $90,000$40,000 = 2.25, over the limit. The most the bank can lend is $40,000 × 2 − $60,000 = $20,000. The owner could borrow $20,000 and put in $10,000 of their own money, or wait a year and let retained earnings grow equity first.

10 Where it leads

The second of three statements.

What you're looking at: a map of where this lesson fits in the course. Read it left to right: the lessons it builds on, this lesson in the middle, and the lesson that comes next.

Back · Unit 12Did the business make money?
Back · Unit 11Profitable and still broke
Back · Unit 4Car, student and payday loans
You are hereWhat it owns, what it owes
Next · Unit 12How the three statements connect

Next lesson: How the three statements connect →Course map