Ebrahim AlhamedFrameworks Library

m.01 · I · Reading the Numbers · Accounting Basics & Financial Reports

The Balance Sheet Equation

Arthur Kraft · the three statements and the equation that keeps them honest.

The core idea

Accounting is a language for describing economic reality. The three statements — Balance Sheet (position), Income Statement (performance), Cash Flow (liquidity) — are held together by one equation: Assets = Liabilities + Equity. Every transaction is a double entry that keeps the equation true, and that discipline is what makes the numbers comparable. — after Kraft

The hero diagram

The equation behind every balance sheet.

Rearrange this however you like. It never breaks.

ASSETS = LIABILITIES + EQUITY

The rules on the page

The rules of the game.

Three Statements · IFRS / US GAAP
Balance Sheet · Income Statement · Cash Flow Statement
Retained earnings flow from IS → BS. Operating cash flow starts from IS.
Double-Entry Bookkeeping · Accounting Convention
Debits · Credits · T-accounts
Every transaction affects at least two accounts. Debits = Credits, always.

How to apply

First pass at any annual report.

  1. Start with the balance sheet. Assets on one side, liabilities + equity on the other. They must balance.
  2. Trace one transaction. A cash sale. Where does it appear? IS (revenue), BS (cash up, inventory down), CFS (cash inflow).
  3. Find the retained earnings line. It connects net income from the IS to owner's equity on the BS.

Key reading · Session 1 · Kraft

Basics of accounting and financial reports.

The balance sheet equation is the one rule that makes accounting coherent. Everything else — recognition, measurement, valuation — is a refinement of how we assign numbers to the left and right sides so they describe the business honestly.

Everything in financial accounting is a re-statement of A = L + E.

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