The First Financial Statement: The Balance Sheet + Net Worth

September 2004

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The First Financial Statement: The Balance Sheet

The balance sheet had to have been the very first financial statement ever created. It is also the most informative and comprehensive financial statement.

It expresses the relationship that is fundamental to the double-entry accounting system (you know, those confusing debits and credits). That relationship is

Assets = Liabilities + Equity

So on one side of the balance sheet, we see the assets. On the other side, we see liabilities and equity.

This relationship between assets, liabilities, and equity actually makes better sense if we view it from another angle.

Again, the basic equation of the balance sheet is:

Assets = Liabilities + Equity

A more intuitive way to express this equation is:

Assets – Liabilities = Equity

Or in very simple language:

Assets – Liabilities = Equity

J - L = J or L

Happy – Sad = Either Happy or Sad

Assets are happy things that you own.

Liabilities are sad amounts that you owe other people.

Equity is the difference between the two…either a happy or sad remaining balance.

Equity from a Personal Perspective

Equity is a concept that many of us are comfortable with because of our homes. We have equity in our homes because the amount that the house is worth is more than the amount we owe on it.

Have you refinanced your house recently? When you did, they asked you for all sorts of information on your financial health and ability to repay the loan. You likely created a personal balance sheet for the bank.

The first thing you did was to list all of your assets – all the cool stuff you own that you could sell off for cash if you needed to repay the loan. Your assets would include the house, a car, some investments, your retirement account, a beach house, some jewelry, etc.

Then you had to list all of your liabilities – the amounts you owed on all this stuff. So you had to list your mortgage, your car note, your beach house mortgage, your credit card debt, etc.

The difference between the two – assets and liabilities – is your equity, or in personal terms, net worth. You have heard the term net worth applied to wealthy folks, such as in “Ross Perot has a net worth of $10 billion.” This does not mean that Ross Perot has $10 billion in a bank account in Switzerland. It means that his stuff is worth $10 billion more than he owes on it. He has equity in his real estate and business holdings.

When I was in my 20’s, I had a negative net worth. I owed more on my car, my house, and my credit cards than I had. I was “upside-down” in my life! Twenty years later, I finally have a positive net worth because of my retirement savings and my less flashy lifestyle.

Businesses are like this, too. They list their assets and then their liabilities. The remainder is the equity that has built up in the company.