Some Basic Financial Terms for Layman

Everyday we manage our finances and it is good thing to know some basic financial terms just to understand things in a better way. People might ignore it and would like to outsource things to the financial guys but its today's requirement to know our finances in a better way so that it can be managed properly and we can make sure we are not getting cheated. Below are some of the basic things or terms which you should know and which are used almost daily.

If we see in Layman's way then everything in accounts is basically categorized in to 5 fundamental types of “accounts”. Which means that everything that       accounting deals with can be placed into one of these 5 accounts:

    * Assets - things you own.
    * Liabilities - things you owe.
    * Equity - overall net worth.
    * Income - increases the value of your accounts.
    * Expenses - decreases the value of your accounts.

It is clear that it is possible to categorize your financial world into these 5 groups. For example, the cash in your bank account is an asset, your mortgage is a liability, your paycheck is income, and the cost of dinner last night is an expense.

How are they related:

Now we need to learn that how the above five terms are related to each other or in other way how does one type of account affect the others. Firstly, equity is defined by assets and liability. That is, your net worth is calculated by subtracting your liabilities from your assets:

Assets - Liabilities = Equity

You can increase your equity through income, and decrease equity through expenses. This makes sense of course, when you receive a paycheck you become "richer" and when you pay for something you become "poorer". This is expressed mathematically in what is known as the Accounting Equation:

Assets - Liabilities = Equity + (Income - Expenses)

This equation must always be balanced, a condition that can only be satisfied if you enter values to multiple accounts. For example: if you receive money in the form of income you must see an equal increase in your assets. As another example, you could have an increase in assets  if you have a parallel increase in liabilities.

For every change in value of one account in the Accounting Equation, there must be a balancing change in another. This concept is known as the Principle of Balance.

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