Every business, from Meera's cart to Apple, obeys one identity at every instant:
Assets = Liabilities + Equity
What do the two sides of the equation mean?
Read it as a question and an answer.
- Left side, Assets: what economic resources does the business control? Cash, inventory, receivables, machines, buildings, patents. The formal version: resources controlled by the entity, arising from past events, expected to produce future economic benefit.
- Right side: who has a claim on those resources? Two kinds of claimants, in strict order:
- Liabilities are outsiders' claims. Think of suppliers you owe (accounts payable), banks you borrowed from (loans), employees you haven't paid yet (salaries payable) and customers whose advances you haven't earned yet (unearned revenue). They're fixed in amount and first in line.
- Equity is the owners' claim, whatever is left after every outsider is paid. You won't find it as a pile of money sitting anywhere. It's a residual claim, defined by subtraction:
Equity = Assets − Liabilities. That's why equity is also called net worth, net assets, or, on Indian balance sheets, shareholders' funds.
This equation can't fail the way a hypothesis can. It's true by construction, the way both sides of a coin are the same coin. Assets are the resources. Liabilities plus equity are the financing of those resources, because every rupee of stuff was paid for by someone, either a creditor or an owner. Accountants call the two sides "what you have" and "who funded it."
Advertisement
Accounting equation examples: Infosys and Apple
See it on a real Indian balance sheet. Here's Infosys, consolidated. These figures are illustrative, modeled on ~FY25 scale, so pull the actual annual report from infosys.com or BSE and verify them. You'll do just that in the applied mini-project.
- Total assets ≈ ₹1,40,000 crore (cash and investments, receivables, office campuses, and so on)
- Total liabilities ≈ ₹46,000 crore (payables, unearned revenue from client advances, lease obligations, and famously almost no borrowings)
- Equity (shareholders' funds) ≈ ₹94,000 crore
Check: 46,000 + 94,000 = 1,40,000. It'll balance on the real filing too, to the crore, because the equation can't fail to balance.
And on a US balance sheet, here's Apple's 10-K. Again it's illustrative, modeled on ~FY24 scale, so pull the actual 10-K from SEC EDGAR.
- Total assets ≈ $365bn
- Total liabilities ≈ $308bn
- Shareholders' equity ≈ $57bn
Same equation, and your first taste of analytical insight. Apple is one of the most valuable companies on earth, with a market value in the trillions, yet it shows book equity of only ~$57bn. Why so small? Apple has returned hundreds of billions to shareholders through buybacks and dividends, and as you're about to learn, those reduce equity. Still, the equation balances. It always does. The gap between book equity and market value is a story for Phase 3. For now, notice that the balance sheet records history at recorded values. It doesn't tell you what the business is worth.