Most businesses have four primary ways to get the funding they need to support ongoingoperations: from external debt, investments by the owner(s), raising venture capital fromoutside investors, and the business’s earnings. Without such capital, a businesscan’tcontinue to produce goods or services — and the owners can’t withdraw money ifthe coffersbecome empty. Of those three funding approaches, the latter two — owner investmentsand thebusiness’s earnings — make up the owner’s equity in a business.Owner’s equity is animportant measure to help owners understand the value of their stake in their business.
What Is Owner’s Equity?
Owner’s equity describes the extent of a company’s ownership —specifically, the portion of acompany’s value held by the sole proprietor, partners orshareholders with a claim in the business. It is often considered to be thecompany’s “net worth.” For widely-held companies, which tend to bepublicly traded, owner’sequity is more commonly referred to as “shareholders’ equity.” The amountof a company’sequity can be calculated by subtracting the company’s liabilities from its assets. Liabilities must be subtracted first because, inthe case of a sale or liquidation, those must be paid before the owner can collect anyremaining funds.
For normal day-to-day business analysis, owner’s equity is both a valuable indicationof abusiness’s financial health and a way to track whether the company is gaining orlosingvalue over time. Many owners use equity to demonstrate their company’s value tolenders whenseeking external capital or trying to raise capital from outside investors.
Key Takeaways
- Owner’s equity is the portion of a company’s assets that an owner can claim;it’s what’sleft after subtracting a company’s liabilities from its assets.
- Owner’s equity is listed on a company’s balance sheet.
- Owner’s equity grows when an owner increases their investment or the companyincreasesits profits.
- A negative owner’s equity often shows that a company has more liabilities thanassetsand can signify trouble for a business.
- Positive and increasing equity indicates a healthy, growing company.
Owner’s Equity Explained
Owner’s equity is the share of a company’s net assets that the owner — orowners — can claimas their own. A common misconception is that owners can claim everything in abusiness, but some assets must be used to cover the liabilities owed to creditors, lendersor others to whom the business has obligations. Therefore, owners may own only a portion ofthe value of assets — the company’s equity. For example, if a business buys apiece ofequipment valued at $20,000, but purchases it with a $15,000 loan, the owner’s equityin theequipment is the difference between the asset and the liability — in this case,$5,000.
Equity can also be illustrated by looking at what happens when a company liquidates itsassets. First, all liabilities must be paid from the proceeds of asset sales. So, beforeliquidating, businesses should study their equity to see what remaining assets will go tothe owner(s) or shareholders once all bills are paid. A business may have highly valuedassets, but if it also has high liabilities, an owner may end up with significantly lessthan expected by the end of the process.
What’s Included in Owner’s Equity?
For privately owned businesses like sole proprietorships and partnerships, owner’sequitymainly includes the following categories, which either increase or decrease an owner’soverall equity:
Capital investments from the owner (increase).
Many business owners use their own money and assets (e.g., equipmentor vehicles) to fund their businesses, especially when firststarting up.
Retained earnings generated by the business (increase).
Once a business is up and running, retained earnings contribute topositive equity growth and increase the overall value of the company. This is animportant measure because it’s the capital available from the business’soperationsthat can be used for reinvestment or paying down debt.
Money withdrawn by the owner (decrease).
Owners often withdraw money from their business. But if they taketoo much, it can push a business’s equity into negative territory. Businessescanrecover from negative equity, but long-term negative equity is unsustainable becausethe business will ultimately be unable to pay its liabilities.
Losses generated by the business (decrease).
If a business’s core operations are consistently losing money,thebusiness may not be able to survive. Continued losses erode equity unless changesare made or the business gets a cash injection to turn things around.
For publicly traded companies, which usually refer to owner’s equity asshareholders’ equityor stockholders’ equity, several additional types of transactions can raise or lowerequityand must be reported on the company’s balance sheet. These include:
Dividends and distributions (decrease).
Dividends and other financial distributions are paid from abusiness’s net income, which would otherwise go into retained earnings.Comparingretained earnings to net income is useful: A business may show positive net income,but if dividends exceed income, it can create negative cash flow and impairequity.
Outstanding shares (increase).
When a company sells additional shares to the public, it raisescapital that adds to equity in the same way as when an owner contributes capital.The par value of the additional shares sold appears on the balance sheet under“outstanding shares.”
Other capital (increase).
Companies usually issue stock at a higher price than par value; anycapital raised above the par value is classified as “other capital/additionalpaid-in capital (APIC)” and contributes to owner’s equity.
Treasury stocks (decrease).
When a company repurchases its stock from investors, thecompany-owned shares are called treasury stocks; they are listed as such on thebalance sheet, and they reduce owner’s equity. But that may not be the end ofastock buyback story: By reacquiring stock, companies are spending money now toreduce their dividend payments in the future, which can lead to higher retainedearnings — and, thus, higher owner equity.
How to Calculate Owner’s Equity
Owner’s equity is a key variable in the classic accounting equation, Assets =Liabilities +Owner’s Equity, by which a company’s balance sheet literally “balances.” (Ifit doesn’t,there may be accounting errors or financial statementfraud.) To solve this equation for owner’s equity, rewrite it as:
Owner’s Equity = Assets - Liabilities
To illustrate the calculation, a simplified balance sheet for the fictional RCL ManufacturingCo. is shown below. A real balance sheet would typically include more detailed breakdowns ofassets and liabilities.
RCL Manufacturing Co.
Balance Sheet as of 31 December 2021
| Assets | ||
| Current Assets | $500,000 | |
| Long-term investments | $75,000 | |
| Property, Plant & Equipment | $400,000 | |
| Other Assets | $10,000 | |
| Total Assets | $985,000 | |
| Liabilities | ||
| Current Liabilities | $500,000 | |
| Long-term Liabilities | $200,000 | |
| Total Liabilities | $700,000 | |
| Owner's Equity | ||
| Owner's Contribution | $60,000 | |
| Minority Interests | $10,000 | |
| Owner's Draw | $45,000 | |
| Earnings | $260,000 | |
| Total Owners Equity | $285,000 | |
| Total Liabilities and Owner's Equity | $985,000 | |
RCL’s assets total $985,000 and its liabilities total $700,000. Subtracting liabilitiesfromassets yields owner’s equity of $285,000. At the bottom of the balance sheet, theowner’sequity section includes earnings, owner’s contributions/draws and any equity fromcompaniesthe parent company has a minority interest in — also adding up to $285,000. Thesefiguresmust match — “balancing” the accounting equation — before thebusiness can close its books for the periodending December 31,2021.
Statement of Owner’s Equity
A statement of owner’s equity is a more detailed document than the equity section ofthebalance sheet, and it depicts how equity changes over a period of time. For soleproprietorships and privately held businesses, the statement of owner’s equity showstheequity at the beginning of the time period, net income, any additional investments orwithdrawals by the owner(s) and any non-cash contributions, such as equipment. The statementof equity may also show nonrecurring factors, like gifts or forgiven debts. These figuresshould match the equity total on the balance sheet.
If a previous period’s books have been closed and an adjustment needs to be made— forexample, because of mathematical errors, misapplied accounting rules or a company migratingfrom cash-basis toaccrual-basis accounting — “prior period adjustments” may appearin the statement ofowner’s equity.
Below is a sample of a statement of owner’s equity showing an expansion of equityduring theperiod shown above for RCL Manufacturing.
RCL Manufacturing Co.
Statement of Owner's Equity 11/30/21 -12/31/21
| Beginning Equity As Of 30 November 2021 | $900,000 |
| Owner's Additional Cash Contribution | $20,000 |
| Additional Non-Cash Investment From Owner | $5,000 |
| Net Income | $70,000 |
| Owner's Draw | $15,000 |
| Prior Period Adjustments | $5,000 |
| Ending balance of Owner's Equity | $985,000 |
In contrast, below is a sample of a statement of shareholders’ equity from a fictionalpubliccompany, “RCLCorp.” Statements of shareholders’ equity showbeginning/ending equity and netincome, as well as dividends, additional paid-in capital and stocks.
RCLCorp.
Statement of Shareholder's Equity 11/30/21 - 12/31/21
| Beginning Equity As Of 30 November 2021 | $2,300,000 | |
| Net Income | $500,000 | |
| Dividends | $200,000 | |
| Retained Earnings | $300,000 | |
| Common Stock | $75,000 | |
| Treasury Stock Purchases | $50,000 | |
| Additional Paid-In Capital | $90,000 | |
| Ending balance of Stakeholders's Equity | $2,715,000 | |
Owner’s Equity Examples
To further illustrate owner’s equity, consider the following two hypothetical examples.
A transportation and delivery company is seeking new investors and wants to calculate theequity in the company to show the business’s value. Its assets include a fleet oftrucks,repair equipment and a parking garage. Its liabilities include vehicle loans, credit carddebt, a mortgage for the garage, payroll and taxes
- Assets: $1,200,000 (vehicles) + $100,000 (equipment) + $575,000(garage) = $1,875,000
- Liabilities: $300,000 (vehicle loans) + $40,000 (credit cards) +$100,000 (mortgage) + $200,000 (payroll) + $70,000 (taxes) = $710,000
- Owner’s Equity: Assets - Liabilities, or $1,875,000 - $710,000 =$1,165,000
The owner’s claim in the company is $1.165 million.
Another business, a wholesale restaurant supply distributor, is considering liquidation andwants to know how much equity is in the business. The owner lists the values of thecompany’s assets — property, equipment, inventory, accounts receivable(AR) and cash — and liabilities — mortgage, line of credit debt, taxliability,accounts payable (AP), payroll and other liabilities.
- Assets: $500,000 (property) + $50,000 (equipment) + $225,000(inventory) + $30,000 (AR) + $7,500 (cash) = $812,500
- Liabilities: $125,000 (mortgage) + $15,000 (line of credit) + $20,000(taxes) + $15,000 (AP) + $150,000 (payroll) + $10,000 (other) = $335,000
- Owner’s Equity: Assets - Liabilities, or $812,500 - $335,000 =$477,500
The owner should expect $477,500 left in the company after all liabilities have been paid.
Owner’s Equity vs. Business Fair Value
Owner’s or shareholders’ equity isn’t always equivalent to acompany’s market value — infact, equity is usually lower than a business’s fair value, which is the estimatedpricethat both a seller and buyer agree is “fair.” Mainly, this is because accountingrulesrequire that assets be recorded on the balance sheet at the lower of either the historicalcost — the original cost the asset was acquired for — or the net realizablevalue (NRV),which is an estimate of how much money the asset could be sold for, minus selling costs.
Meanwhile, a business’s fair value factors in additional considerations, like brandstrength,expected future returns, intellectual property, cash flow and anything else either partybelieves contributes to the business’s value. Other factors can contribute to a higherorlower sales price, too — like a company prioritizing a quick sale to stave off animpendingbankruptcy. Because of the subjectivity that can accompany values like “brandstrength,” acompany’s market value may be higher than the owner’s equity.
How to Increase Owner’s Equity
There are only a few ways to increase owner’s equity in a business. The first is fortheowners to invest more money in the business (in the case of a private company), bring onadditional equity partners or authorize more shares of stock for sale (in the case of apublic company). The second is to decrease a company’s liabilities, such as byrefinancinghigh interest rate debt with lower rate options or reducing employee costs. The third, andmost advantageous, way to increase equity is to increase profits, which then flow intohigher retained earnings. This can be achieved by increasing revenue and/or increasing theefficiency of operations.
Protect Your Company’s Equity Now
While increasing owner’s equity can bedifficult,decreasing it is unfortunately all too easy when an economic slowdown occurs.Proactively protect your company’s financial health today with this practicalseven-step guide.
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Owner’s equity, the portion of a company’s value that owners or shareholders canclaim, tellsa lot about a business’s health, so it’s important to understand and analyze itscomponents.If profits are the main driver of equity growth, rising owner’s equity can be a goodsign ofa financially healthy company. But if increased capital investment is the main driver, itcould mean owners are trying to prop up a business that has insufficient cash and anemicprofits. Details of owner’s equity can be found in the last section of acompany’s balancesheet and in a separate statement of equity. Whether you’re a company owner or anoutsiderinvestor, owner’s equity is an important factor to help gauge a business’s networth.
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Owner’s Equity FAQs
What is equity?
Equity is the value remaining from a company’s assets after all liabilities have beensubtracted. For example, if a business buys a piece of equipment valued at $20,000, butpurchases it with a loan totaling $15,000, the equity in the equipment is the differencebetween the asset and the liability — in this case, $5,000.
What is owner’s equity and examples?
Owner’s equity is the asset value left in a company after liabilities have been paid.Forexample, if a transportation/delivery company has assets — a fleet of trucks, repairequipment and a parking garage — totaling $1,875,000, and liabilities — vehicleloans,credit card debt, a mortgage for the garage, payroll and taxes — totaling $710,000,theowner’s equity would be the difference between them — $1,165,000.
Where is owner’s equity?
Owner’s equity can be found on a public company’s statement of equity and at thebottom ofits balance sheet, below assets and liabilities.
Is owner’s equity an asset?
The value of owner’s equity is derived in part from a company’s assets, butowner’s equity isnot itself an asset. Owner’s equity is calculated as the total value of acompany’s assetsminus the company’s liabilities. A company with higher assets than liabilities willshow apositive owner’s equity.
Can owner’s equity be negative?
Yes. Owner’s equity is negative when a company’s liabilities exceed its assets,which canhappen in a small business, for example, if the owner withdraws too much money from thecompany. Negative equity can create long-term problems for a business because it indicatesthat the company doesn’t have enough capital to support its operations.
What is shareholders’ equity?
For widely held public businesses with shareholders, owner’s equity is more commonlyreferredto as “shareholders’ equity.” Shareholders’ equity includesoutstanding stocks, additionalpaid-in capital, treasury stocks, dividends and retained earnings.
What is an equity interest?
Equity interest refers to the share of a business owned by an individual or another businessentity. For example, a stockholder with a 20% equity interest owns 20% of the business.
