UNDERSTANDING ACCOUNTING TALK 17: Debt vs Equity

From the discussions of the generally and commonly used listing of Liabilities and Equity in a Balance Sheet (posts 11 through 16), the basic accounting equation can thus be re-stated in more detail:

Retained Earnings (for corporations) and Drawings (for sole proprietorships & partnerships), from the stockholders’ & owners’/partners’ point of view, can serve the same purpose, i.e. as a source of cash or income. Stockholders can receive dividends from a distribution of Retained Earnings; and Owners or Partners can draw from the business.

As can be seen graphically, Assets are either owned by the business (Equity) or they are burdened by claims from Liabilities. The basic accounting equation dictates: the more Liabilities, the less Equity, and vice versa. In other words, the more assets your creditors can have a claim on, the less is your actual ownership of the business.

Obviously, the less Liabilities, the healthier is the business.