Expanded Accounting Equation
Candlefocus EditorThe expanded accounting equation has three components: Assets, Liabilities and Equity. Assets are the economic resources that provide a company with the ability to generate future economic benefits. These can include cash, investments, accounts receivable, inventory and other assets. Liabilities are defined as obligations or debts that must be paid off eventually by the company. This can include short-term and long-term debt, or simply money owed to suppliers and lenders.
Equity is the difference between Assets and Liabilities. This is broken down into three categories: Contributed Capital, Retained Earnings and Revenue Minus Dividends. Contributed Capital is the money a company has received from investors in return for ownership interests, either in the form of stock or debt. Retained earnings refer to the profits that the company has kept and reinvested into the business. Finally, revenue minus dividends indicates the amount of revenue left after dividends are paid out to stockholders.
In essence, the expanded accounting equation is a users tool that allows investors, lenders and other interested parties to have a much more comprehensive and transparent view of a company’s financial position. It helps to assess the company’s ability to generate economic benefits, pay off its obligations and assess the true value of the company’s assets and liabilities. With the expanded accounting equation, users can easily compare different companies and identify which are better positioned to weather economic downturns, generate growth, and develop long-term investment strategies.