Why Balance Sheet Is Always Equal?

Accounting equation is not something like complex mathematical equations such as E=mc². It is easy to understand if you understand the basic concept of doing business.

Let’s understand this with a simple example.

You are doing a business of trading electronics equipment such as refrigerators, air conditioners, etc. For this, you need certain resources e.g. office building, stock/inventory of refrigerators, etc and some amount of cash. These resources are known as assets of the business.

How do you finance these assets or in simple terms where do the funds come from to obtain these assets? The answer is simple. You will either invest your own money in the business (we call it capital or equity of the business) or you will have to obtain loan from a bank or a friend that you will have to repay later on (we call it as liabilities of the business). So, basic accounting equation simply means that total assets of the business equal the total of its equity and liabilities.

This is a very simple and powerful idea. This equation provides basis for recording accounting transactions. Whole idea of financial statement preparation revolves around this equation. That’s why, a balance sheet is always equal.