I should have added in the last post about the assignment answers I have been getting – a basic rule of accounting. The total of liabilities plus stockholders equity is always exactly equal to the assets. If the company’s assets equals $1 million for example, the liabilities plus stockholders equity will also equal $1 million. If you own a car worth $30,000 and you owe $10,000 on it, your equity is $20,000.
The relationship between debt and equity is a telltale sign of the financial health of the company. The more the liabilities exceed the equity, the shakier the financial health is. A company with $1 million in assets and $950,000 in debts is “highly leveraged.” Its profits are going to go to pay the liabilities instead of to shareholders. To the extent the liabilities are accruing interest, the profit is going to pay the interest rather than dividends.