If you haven't read the previous article, please read it here. In this article let us balance the business by creating it.
Remember, ALOE
Assets = Liabilities + Owner's Equity
A L OE
What business own = Assets
What business owe = Equity
Before starting further, Owner equity (OE) is a broader term that includes Capital(Amount from the owner) and Retained Profits(Profit not taken out and reinvested again or held for future use).
So for starting a business,
Assets = Liabilities + Capital
A L C
Let us start a tea shop business with an amount Rs.1 lakh.
Therefore Capital = 1 lakh. Now I need to increase the assets by 1 lakh because the equation must be balanced. Therefore I increase the Cash in assets by 1 lakh
Next, I deposit Rs.50,000 in the bank. Now the only asset changes and not owner money.
I purchase furniture and equipment worth Rs.30000 and gave payment in cash. Here also only asset changes.
I bought milk from a milk supplier worth Rs.5000 and promised him to pay after 1 week through a bank cheque. This is called Credit purchase.
Note: It is 1.08 lakhs
Next, I purchase tea powder and pay it in cash for Rs.5000.Therefore decrease in cash and increase in another asset
Note: It is 1.08 lakhs
I pay the milkman through cheque.
I sold tea for Rs.6000.For this, I used Rs.3000 value of milk and Rs.1500 value of tea powder.
Therefore Profit = 6000 - 3000 -1500 = Rs.1500
This is a simple illustration on how to balance each transaction in businesses.We will complicate transactions in the next article.Stay tuned !