Understanding Company Finances: Assets, Liabilities, and Equity

Posted on Dec 14, 2024 in Economy

Net Worth

Net Worth is calculated by adding the value of one’s property and rights to the amount obtained by subtracting the value of their obligations.

The value of corporate assets must be equal to the value of its liabilities plus equity, so the total assets must be equal to the sum of the values of liabilities and equity. This expression is called the fundamental equation of heritage. It follows that: AP = PN

  • The elements or components are the individual property assets, rights, and obligations that form the heritage. The assets can be grouped according to their nature or their role in the company. These groups constitute the so-called “economic mass”.

Asset Classification Criteria

A widely used approach for the management of assets is their role within the company. According to this criterion, within the set of assets, we can distinguish between those goods that are linked to the company on a permanent basis and represent their permanent investments from those other goods that are linked to the production cycle of the company and constitute its investment performance. There are two types:

  • Non-Current Assets: Consists of all assets and liabilities whose function is to ensure the life of the company, i.e., fixed assets.
  • Current Assets: The whole enterprise whose role is to ensure the operating cycle of the company (raw materials, etc.).

Criteria and Ranking of Equity Liabilities

1. According to the character or unenforceable required funds used by the company:

  • Equity or Unenforceable: Own funds held by the company.
  • Passive or Callable: Formed by debts that the company should have. Within them:
    • Non-Current Liabilities, LP: Debt more than 1 year.
    • Current Liabilities, CP: Debts less than 1 year.

2. According to the character of more or less permanent funds: If we consider the equity and liabilities as a ratio of funds or financial resources made available to the company, there are two types:

  • Permanent Resources: Both the set of equity and the passivity of the LP are resources that are available to the company for a long time.
  • Short-Term Resources: Also known as current liabilities to reinforce the idea that all its elements are debts to the company.

Accounting Books

  • Journal: In this book, the various operations are recorded as they occur. It is, therefore, a book that contains the economic history of the company chronologically. For this story, it uses a methodology that describes every economic fact by special annotations called “accounting entries”, based on the principle of double entry.
  • Ledger: It records the accounts of all assets. Each gate is open; the book represents a different account: the left page is the “debit”, the right is the “credit”.

Balance Sheet

The balance sheet is an accounting document that reflects the heritage of a company, duly appreciated, at any given time.

The criteria to sort the assets is from the lowest to the highest degree of liquidity.

1. Non-Current Assets: Permanent Assets

  • Intangible Assets: Intangible assets are, for example, computer applications.
  • Tangible Assets: Assets are tangible in nature, such as machinery.
  • Accumulated Depreciation of Fixed Assets: Impairment of fixed assets for use.

2. Current Assets

  • Stock: Items that are stored for sale or converted into cash.
  • Receivable: Formed by rights that the company can implement in the short term.
  • Available: Items that are arranged in immediate liquidity, the treasury of the company.

The criteria for the management of the NP and liabilities is from low to high chargeability:

1. Net Equity

Collects the resources or equity of the company.

  • Capital: The contributions of the partners or owners of the company.
  • Reserves: The benefits to the company.
  • Profit for the Year to be Implemented: If the results have been a benefit to the company, the amount will appear with a positive sign, but with a negative sign if there are losses.

2. Liabilities

Constituted by the funds or resources other than those of the company. According to the term:

  • Non-Current Liabilities LP: The accounts that appear in this section shall be representative of loans.
  • CP Current Liabilities: Brings together those debts that will have to be faced in less than 1 year.

Operating Expenses and Income

Among the most common operating income are sales of merchandise, finished products, etc. Among the operating expenses include: procurement, personnel costs, outside services (water, electricity, etc.), depreciation, and amortization.

General Plan of the Structure of Accounting (PGC)

  1. Framework: Includes general rules to be taken into account when making accounting records. The main thing is to reflect the true picture of the company.
  2. Registration and Assessment Standards: The CDP provides the valuation rules applicable to assets.
  3. Annual Accounts: Contains instructions for the preparation of annual accounts.
  4. Table of Auditors: Collects a list of names of all potential assets and liabilities, with the goal that all companies use the same name.
  5. Definitions and Accounting Relationships: Establishes the content and operation of all company accounts.

Annual Accounts

  • The Balance Sheet: Must clearly and accurately reflect the economic and financial situation of the company and the profits or losses at year-end.
  • The Income Statement or Profit and Loss: A most useful document to analyze the various components that have contributed to obtaining the profit or loss.
  • The Statement of Changes in Equity: Collects the changes in the composition of the company’s net equity from one year to another.
  • Notes: Contains the information collected in previous documents and contains additional explanations and details of events and circumstances that help to understand the information from other statements.

Characteristics of Information

  • Relevant: Must be truly meaningful information to users. That is, information useful in making business decisions.
  • Reliable: It is reliable when the annual accounts are free of errors and if that information is neutral, i.e., free from bias.
  • Comparable: The annual accounts must be comparable in order to determine the status and profitability of the company in relation to previous periods or companies of similar characteristics.
  • Understandable and Clear: Must be as clear as possible in order to make more effective decision-making within companies, as well as for external users to understand.

Valuation of Assets

  1. Tangible Assets (Machinery, etc.): The assets included in this group should be assessed for their purchase price, minus the depreciation practiced.
  2. Stocks (Merchandise, etc.): Are valued at their acquisition price or production cost.
  3. Investments in Securities (Shares, etc.): Are valued at their acquisition value.
  4. Customers, Receivables, Debtors: On the balance sheet at their nominal value.
  5. Losses from Previous Years: These losses are reflected in the impaired person’s own funds.