As an entrepreneur that runs their own business, you've probably invested a good chunk of your own money into your company. And owner's equity is the money that your business owes you.
The value of your business minus all of its liabilities is equity. If you want to know what your company is worth in case you decide to liquidate it, calculating owner's equity is necessary. Read on for more information.
What Is Owner's Equity?
Owner's equity is the asset that remains after a business has paid off all of its debts and liabilities. These assets belong to the owner of a business, typically in a sole-proprietorship structure, like in small to medium design firms.
In the case of corporations, such an asset is called stockholder's equity, while for LLCs, it is referred to as shareholder's equity. In essence, though, it is quite the same. For eg Equity vs Asset is is anything that is invested in the company by its owner.
If you were to look at your business's balance sheet, owner's equity would be something like the book value of your company instead of reflecting as an asset. This is because it is an asset of the owner and not of the business itself.
In fact, owner's equity can be treated as a liability to the business since it isn't something a business "owns" in and of its right.
The Components of Owner's Equity
In a nutshell, the capital coming into a business minus the capital going out amounts to the owner's investment in the company. This means that various earnings and expenses make up the components of owner's equity.
Business assets, investments, and profits are categorized as incoming capital, whereas debts, payments, and liabilities count as outgoing capital.
Owner's equity can be calculated by subtracting what a business "owes" from what it "owns". Interestingly, this equation makes it possible for owner's equity to be negative, as the amount a business owes to other entities might be greater than the amount it owns.
Let's look at how you can figure out owner's equity in your company in detail below.
How to Calculate Owner's Equity
Mathematically, the owner's equity formula looks like this:
Owner's Equity = Assets - Liabilities
The assets of a business can consist of the following:
- Current Assets: Investments, inventory, cash flow or cash equivalents, cheques, prepaid expenses, etc.
- Fixed Assets: Property, tools and machinery, equipment, furniture, etc.
- Tangible Assets: Buildings, land, vehicles, etc.
- Intangible Assets: Intellectual property, brand, goodwill, etc.
On the other hand, liabilities for a firm often look like this:
- Current Liabilities: Taxes, loans, bills, accounts payable, overdrafts, accrued expenses, etc.
- Long-Term Liabilities: Leases, mortgages, deferred taxes, etc.
- Contingent Liabilities: Lawsuits or any other contingent expenses.
Let's see the owner's equity formula in action with a simple example. Suppose there is a design firm, Example Interiors.
They have their own office, which is valued at $1 million as per the previous years' balance sheets. Their curated artworks and antique furniture are valued at another $1.5 million. Their fleet of service vehicles is worth $500,000.
The firm, according to the books, is working with an active bank loan of $300,000. In addition, the salaries and wages of the firm's employees and contract workers amount to $900,000.
Here is how owner's equity would be calculated in such a scenario:
First, we will calculate the assets of Example Interiors.
Similarly, the liabilities of the design firm are as follows:
Next, we input the values in the formula:
$3,000,000 - $1,200,000 = $1,800,000
Example Interiors' owner's equity value thus stands at $1.8 million.
This figure would be visible in some of the financial statements of the firm. Technically, the owner's equity closing balances must tally with the equity accounts of the firm.
This formula makes it easy to calculate owner's equity in your business. But if you still need some assistance, consider utilizing the professional bookkeeping services offered by Fincent.
Statement of Owner's Equity
Also called Statement of Changes in Equity, Statement of Retained Earnings, or simply an equity statement, this financial document is a report of the changes that happened in the company's equity during a particular period.
Information that can be seen on an owner's equity statement consists of the details of profits earned, dividend distributed, inflow and withdrawals to and from equity, losses, etc.
An equity statement is required to be furnished by companies along with their other financial statements at year-end. The basic line items that appear on an owner's equity statement are:
- Opening Balance: This is the starting amount for all financial calculations on owner's equity for the new financial year. The closing balance of the last year is also the opening balance for the new financial year.
- Net Income: At the end of each financial year, the net income of a company is determined from the profit and loss statements and reflects the income of the company after accounting for all the operating and non-operating expenses.
- Other Income: All the unrecognized, or actuarial, gains of a company that cannot be recognized on the income statement of the company end up in this line item on the owner's equity statement.
- New Capital: The issuance of fresh shares or addition to owner's equity in the form of capital inflow is reflected against this line item in the equity statement.
- Loss: This line item represents the net loss shouldered by the company during the concerned fiscal year. It needs to be subtracted from owner's equity.
- Dividends: When shareholders invest in a company, they receive a dividend on the profits, which is then disbursed to them individually. This is deducted from owner's equity.
- Withdrawals: Any withdrawals made on the company's capital need to be reduced from the total equity.
Each of these line items is then required to be filled in against three particulars in a basic equity statement:
- Capital
- Retained earnings
- Net income
Continuing with the instance of Example Interiors, let's say with an opening balance of $350,000, their income was $300,000. To this, the owner contributed $50,000.
In addition, the company liquidated some shares and gained $100,000. However, there was a loss of $250,000 due to the coronavirus pandemic.
All these items would then appear in an equity statement as follows:
The Takeaway
Calculating owner's equity is pretty straightforward math if you know where to begin and what to account for. Use this definitive guide to owner's equity to understand what all those numbers mean.
Alternatively, it is prudent to ask for a professional bookkeepers help in matters like these. Fincent, a modern, professional and reliable bookkeeping service, is designed to give creative small businesses a stress-free experience when managing their books.