Any household striving to build sustainable wealth must understand the concepts of assets, liabilities, revenue and expenses. If a household were a living creature, these would be the most fundamental signs. A household’s financial position in the society is determined by two basic elements; assets and liabilities. Revenue and expenses reflect the movement of finances through the day-to-day activities of the household. To build wealth, all these elements must be put in perspective.
Understanding Assets and Liabilities
An asset, according to accounting principles, is anything a household or family possesses that is able to offer economic benefits moving forward. Some examples of assets in a household include cash, stock, equipment, land, buildings, and accounts receivable. Liabilities, on the other hand, are household obligations, for instance, money owed or services that are supposed to be rendered. Examples of liabilities include rent, bills, any repair and maintenance and so on. A prosperous household has a lot more assets than liabilities. This, essentially, means that the household or family has more than required resources to accomplish any obligation. On the flip side, a household whose liabilities supersede its assets is in big trouble.
Understanding revenue and expenses
Revenue is the amount of money the household earns from the day-to-day business activities. If, for example, the family owns a restaurant, the remittances from customers who eat in the restaurant is known as revenue. Expenses are the specific costs the family incurs in the process of revenue generation. To narrow it down, the ingredients you purchase to prepare food, pay the wages of the restaurant employees, the utilities and rent of the premises are all classified as expenses. For a household to prosper, revenue must supersede expenses. This illustrates why most families build wealth fast while others remain stagnant for years. Families with more revenue than expenses forge ahead exponentially while those with more expenses than revenue experience stagnant situations.
Why a Household (family) should know the importance of Assets, Liabilities, Revenue and Expenses
Assets, liabilities, revenue and expenses brought together are known as the accounting equation. A household should understand the accounting equation because it helps to control the entire accounting process, understanding the effect of every transaction on the family’s equity, assets and liabilities. One of the top advantages of knowing the accounting equation is that it assists in determining whether the family is succeeding in building wealth or fails. For example, if the family’s equity skyrockets, it’s an indication of success and vice versa.
Another reason why a household should know the accounting equation is that it allows for the discovery of the 3rd element of financial situations. For instance, if the asset and liability figures are laid out, it would be easy to ascertain the value of the capital.
A time comes when your accountant wants to make adjustments to financial entries. In such a scenario, the accounting equation would be handy, because it enables the accountant to ensure the efficiency of business operations by ascertaining the debit and equivalent credit of household business transactions.
With all said, it’s apparent that knowing the importance of assets, liabilities, revenue and expenses is key to any future prospect of family wealth building.