If you haven't read the last post. Please read it here. It gives you a basic idea for this article.
To sum up, the whole business can be contained into this single equation.
Asset = Equity
What business own = Assets
What business owe = Equity
Let us understand the Equity part first. So what exactly is equity? Observe here,
We start a business by putting in money. Business takes this money and convert it into assets(Cash, Inventory, Land, Vehicles, Machines etc). If I myself put all the money needed for the business, I am the sole owner right!. The process is the conversion of my money into assets.(Note:Owner money = Equity)
This is the simplest case. But in reality, you don't have all the money required by the business. So you borrow from others. Now above illustration becomes,
Now Business has two sources of funds, one from the owner itself and the other from the lender. This lender can be banks, chits, private lenders, family etc. The lender doesn't have any liking to do your business, they just need interest amount from the lending. Therefore they can't be put on the same plate with owners. So the equation becomes,
Assets = Liabilities + Owner's Equity
A L OE
Whatever money borrowed for business = Liabilities
Enough of theory, let me give you an example. Say I start a tea shop. For a tea shop, I need
Boiler - Rs.20000
Utensils - Rs.10000
Furniture - Rs.5000
Total = Rs.35000
Amount I have in hand is just Rs.20000 so I borrow Rs.15000 from my friend who has no interest in doing the tea business.
From a business point of view,
Here Owner equity is my money = Rs.20000
Liability is Rs.15000
All this money is converted into assets by the tea business. Assets are boiler, utensils and furniture.
Assets is 35000
Here Assets = Liability + Owner equity (ALOE)
This business account is said to be balanced because assets and liability+Owner equity is equal!