Accounting equation
Learn what the accounting equation is, why assets = liabilities + equity, and how it keeps your books balanced.
Published Friday 24 July 2026
Table of contents
Key takeaways
- The accounting equation is assets = liabilities + equity, and it's the foundation of double-entry bookkeeping.
- Rearranged, it shows your equity, or net worth, as what you own minus what you owe.
- Every transaction affects at least two accounts, so both sides of the equation always stay balanced.
- The equation sits behind your balance sheet and shows whether your business is solvent.
What is the accounting equation?
The accounting equation is the foundational formula in accounting, written as assets = liabilities + equity. It shows how the net worth (equity) of your business comes from the things you own (assets) on one side and the debts you owe (liabilities) on the other.
Because both sides always match, the equation helps you check that your books are accurate and gives you a quick read on the financial health of your business.
The accounting formula
The full formula is short and easy to remember. Here it is again in plain text, followed by what each part means.
Assets = liabilities + equity
- Assets are the things your business owns, including buildings, vehicles, work tools, office equipment, inventory, cash in the bank and even money owed by customers. They can also cover intangible assets like licences, copyrights, trademarks and other forms of intellectual property.
- Liabilities are the amounts your business owes. These include debts like unpaid bills, overdrafts, credit cards and long-term loans, plus things like holiday pay owed to workers and tax that hasn't yet been paid.
- Equity is the net worth of your business. It's what you'd be left with if you sold all your business assets and used the money to pay off every business debt.
An intuitive version of the accounting formula
You can rearrange the equation to put equity on its own, which makes it a little easier to see how assets and liabilities interact. In this form it reads equity = assets − liabilities.
Written this way, you can see how the book value, or owner's equity, of your business rests on known figures: the value of what you own and the size of what you owe.
The accounting equation and double-entry bookkeeping
The equation stays balanced because of how transactions are recorded. Under double-entry bookkeeping, every transaction affects at least two accounts, so a change on one side of the equation is always matched on the other.
For example, if you buy equipment with cash, one asset goes up while another goes down, and the totals still agree. To confirm everything lines up, you can run a trial balance, which checks that your debits and credits match.
The expanded accounting equation
The basic equation treats equity as a single figure, but you can break it down to see what drives it over time. The expanded form spells out the parts that make equity rise and fall.
In this version, equity = capital + income − expenses − drawings. Capital is what you put into the business, income adds to equity, while expenses and drawings (money you take out for personal use) reduce it.
Accounting equation example
A short worked example shows how the numbers come together. Here's how a small business might add up its assets and liabilities to find its equity.
Say a business has RM15,000 worth of equipment, RM16,000 worth of inventory, RM20,000 of cash in the bank, and it's owed RM24,000 by customers. Added together, that's RM75,000 worth of assets. Meanwhile it owes RM37,000 in loans, RM7,000 in taxes and RM6,000 in bills, for total liabilities of RM50,000.
Assets − liabilities = equity
RM75,000 − RM50,000 = RM25,000
So the equity, or net worth, of the business is RM25,000.
How the accounting equation relates to the balance sheet
The accounting equation is the backbone of one of your core financial statements. Your balance sheet, also called the statement of financial position, is simply the equation laid out in detail at a single point in time.
It lists your assets on one side and your liabilities and equity on the other, and the two sides must be equal. That's why the equation matters: if your balance sheet doesn't balance, something in your books needs a second look.
Solvency and the accounting equation
The equation also tells you something important about the stability of your business. Watch what happens when liabilities grow larger than assets.
When the accounting equation gives a negative result, your business owes more than it owns and is said to be insolvent. This means it couldn't pay its debts even if it sold, or liquidated, everything it owned.
Keep your books balanced with Xero
The accounting equation is easier to keep in balance when your records update as you work. Xero uses double-entry bookkeeping behind the scenes, so your assets, liabilities and equity stay in step and your balance sheet is ready when you need it.
Xero can help you keep your books balanced and give you a clear view of your finances, and you can get one month free when you start today.
FAQs on the accounting equation
Here are answers to some frequently asked questions about the accounting equation.
What is the accounting equation formula?
The formula is assets = liabilities + equity. It's sometimes called the balance sheet equation because it's the basis for your balance sheet.
Why must the accounting equation always balance?
It balances because every transaction is recorded in at least two accounts, so a change on one side is matched on the other. If the two sides don't agree, there's likely an error in your records.
What are the three components of the accounting equation?
The three components are assets (what you own), liabilities (what you owe) and equity (your net worth). Together they show where your money comes from and how it's used.
Is equity the same as net worth?
Yes, in this context equity is your net worth: the value left over after you subtract liabilities from assets. It's the share of the business that belongs to you as the owner.
Related terms
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Disclaimer
This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.