Stock 101: Understanding the Meaning of Assets, Liabilities, and Equity in The Market
After reviewing my past articles, I was surprised that my article about PBV and discussion about a stock MVP got high demand. Today, I want to share the basics because I am an investor, and fundamental is the first thing I should consider.
Before sharing about PBV, DER, ROE, etc., I need to tell you the basics: assets, liabilities, and equity. Probably, many of the readers already know about it. But let’s be patient; I will go there in no time. Right now, let’s start with the basics.
Assets, Liabilities, and Equity
Before going into the deep explanations, I would like to create an analogy and think about store A. This analogy was inspired by the video created by “Saham dari Nol”. If you are from Indonesia, consider watching those videos. I recommend it.
Store A has various assets, such as a shop building, business permits, merchandise (books, clotheslines, kitchen utensils, cutlery, etc.), cashier desks, chairs, plastic items, wall clocks, etc., with a total value of around 30 million.
However, not all items in the store are wholly owned by the owner. Some items may still be under debt to other parties. Items that are not wholly owned are referred to as liabilities. For instance, cutlery owned by Mrs Jafar, clothesline owned by Mrs Rudy, kitchen utensils owned by Mr Bani, and books owned by Mr Jody, totalling 20 million, represent liabilities.
Equity, or net capital, is the portion of wealth directly owned by the store owner. For example, the value of the shop building and business permits is around 10 million. So, equity is the difference between total assets and liabilities. From that statements, the assets is 30 million that calculated from 10 million (equity) sum with 20 million (liabilities), understand?
Real World Cases
Let’s break down the financial statements from TSLA. Who doesn’t know Tesla nowadays? Tesla, with Elon Musk, is a very credible person in this century. TSLA released their financial statements on October 20, 2023, which are still unaudited.
Assets
Assets are the resources a company owns or controls with measurable economic value. It represents what a company owns and can use to generate revenue.
Assets are crucial in determining a company’s overall value and ability to meet its obligations. First, let’s find the assets that TSLA have. You can find it on the third page. There, we can see that TSLA has $93,941 in assets. It was in Millions, so it was $93,941 m.
Liabilities
Liabilities are obligations or debts that a company owes to external parties, such as creditors or suppliers. It represents the company’s debts and financial obligations.
Liabilities reflect how much a company owes and to whom, providing insights into its financial health and solvency. Within the same pages, the Liabilities that TSLA has are $39,446 m.
Equity
Equity, also known as shareholders’ equity or net assets, is the residual interest in the company’s assets after deducting its liabilities. It is the ownership interest of the shareholders in the company. Equity signifies the net worth of the company attributable to its shareholders.
Equity is a measure of the company’s financial stability and its ability to generate future profits. The report, on page 4, it is showing that TSLA has $53,466 m.
Interrelationship:
The accounting equation expresses the relationship among assets, liabilities, and equity:
Assets = Liabilities + Equity
Assets = $39,446 m + $53,466 m
Assets = $94,941 m
This equation illustrates that a combination of liabilities and equity funds a company’s assets. It is a fundamental principle in accounting and reflects the balance between what a company owns and owes to its creditors and shareholders.
The calculations above show that Assets are the sum of liabilities added to equity. Since TSLA is not a banking sector, it has more significant equity than its liabilities. It means that TSLA should close their company at this moment. It still has the power to pay its debt.
The Importance of Assessing Liabilities and Equity
Why is it important to understand the difference between liabilities and equity? It relates to the financial resilience of a company. When examining the debt-to-equity ratio, we can assess whether a company tends to face financial difficulties or even bankruptcy. I want to tell this in another article.
Generally, looking for companies with liabilities smaller than their equity is a wise strategy. If liabilities exceed equity, the company may struggle when facing issues or economic pressure.
However, it is essential to note that not all businesses follow this rule, especially financial institutions like banks. For instance, banks tend to have more enormous liabilities than their equity, which is a standard practice in the industry.
Conclusions
In conclusion, it is essential to understand that various external factors, such as war, recession, or economic crises, can influence a company’s financial condition. Therefore, looking beyond just financial ratios and engaging in in-depth research before making investment decisions is always wise.
Stock investment carries risks, and a good understanding of a company’s finances can help investors make more informed and measured decisions. Conduct thorough research and consult financial experts before making significant investment decisions.
So, do you will buying TSLA after read this article?
