What is the accounting equation?

The accounting equation, which is fundamental to accounting principles, states that Assets equal the sum of Liabilities and Equity. This equation reflects the relationship between a company's resources (assets), what it owes (liabilities), and the residual interest of its owners (equity).

In practical terms, all assets owned by a business are financed either by borrowing money (liabilities) or by contributions from the owners (equity). This balance must always hold true; therefore, if a company acquires more assets, it must either take on more liabilities or increase its equity to keep the equation in balance.

Understanding this equation is crucial for analyzing a company's financial position, as it serves as the foundation for double-entry bookkeeping and ensures that every financial transaction maintains the balance necessary for accurate financial statements. This foundational concept allows accountants and stakeholders to assess how resources are managed and to evaluate the overall financial health of a business.