Your business is built on the accounting equation:
Assets = Liabilities + Owners’ Equity
Suppose your business has $100,000 in assets and $30,000 in liabilities. Then $70,000 of your company ($100,000 – $70,000) actually belongs to you.
This is similar to computing net worth (also, assets minus liabilities).
Suppose that you personally own $100,000 in assets (car, house, boat, etc.) and owe $30,000 in debt. Then your personal net worth is $70,000.
In either scenario, if liabilities exceed assets, then your owners’ equity or net worth could actually be negative.
The accounting equation is used to organize the balance sheet.
It is important to pay careful attention to the balance between liabilities and owners’ equity. How much of your company has been financed with liabilities ($30,000) versus owners’ equity ($70,000)? The more liabilities, the greater the financial risk.