Balancing a New Business

An owner registers their new company with the state department of business licensing. They take their business license down to the bank and transfer $20,000 of their own money into a new business account. They have now “capitalized” their business, which means they made a contribution to capital, which increases owner’s equity.

At the same time, they have increased the balance in their checking account. From a bookkeeping perspective, you have to make two entries for this one business transaction, and these two entries balance each other out.

[latex]\text{A}=\text{L}+\text{OE}[/latex]

[latex]\$20,000=\$0+\$20,000[/latex]

Now, suppose the owner also borrows $5,000 from the bank, which is then deposited into their account. A loan will not increase their equity. It is not a capital contribution. It is debt, which is a liability.

Now, the equation looks like this:

[latex]\text{A}=\text{L}+\text{OE}[/latex]

[latex]\$25,000\left(\text{cash}\right)=\$5,000\left(\text{bank loan}\right)+\$20,000\left(\text{original capital contribution}\right)[/latex]

Assets are what the business owns. Liabilities are what it owes, and equity is the amount of the company that belongs to the business owner.

Balance in a Home Loan

Think of the equation in terms of a house. Say the house costs $250,000 and you owe $200,000 to the bank. Your equity in the home is $50,000.

[latex]\text{A}=\text{L}+\text{OE}[/latex]

can also be stated as:

[latex]\text{A}-\text{L}=\text{OE}[/latex]

[latex]\text{Assets}=\text{Liabilities}+\text{Owner's Equity}[/latex]

In the case of the house cited above, the equation is [latex]\$250,000 - \$200,000 = \$50,000[/latex].