Most businesses have four primary ways to get the funding they need to support ongoing operations: from external debt, investments by the owner(s), raising venture capital from outside investors, and the business’s earnings. Without such capital, a business can’t continue to produce goods or services — and the owners can’t withdraw money if the coffers become empty. Of those three funding approaches, the latter two — owner investments and the business’s earnings — make up the owner’s equity in a business. Owner’s equity is an important 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 a company’s value held by the sole proprietor, partners or shareholders with a claim in the business. It is often considered to be the company’s “net worth.” For widely-held companies, which tend to be publicly traded, owner’s equity is more commonly referred to as “shareholders’ equity.” The amount of a company’s equity can be calculated by subtracting the company’s liabilities from its assets. Liabilities must be subtracted first because, in the case of a sale or liquidation, those must be paid before the owner can collect any remaining funds.
For normal day-to-day business analysis, owner’s equity is both a valuable indication of a business’s financial health and a way to track whether the company is gaining or losing value over time. Many owners use equity to demonstrate their company’s value to lenders when seeking external capital or trying to raise capital from outside investors.
- Owner’s equity is the portion of a company’s assets that an owner can claim; it’s what’s left 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 company increases its profits.
- A negative owner’s equity often shows that a company has more liabilities than assets and 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 — or owners — can claim as their own. A common misconception is that owners can claim everything in a business, but some assets must be used to cover the liabilities owed to creditors, lenders or others to whom the business has obligations. Therefore, owners may own only a portion of the value of assets — the company’s equity. For example, if a business buys a piece of equipment valued at $20,000, but purchases it with a $15,000 loan, the owner’s equity in the equipment 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 its assets. First, all liabilities must be paid from the proceeds of asset sales. So, before liquidating, businesses should study their equity to see what remaining assets will go to the owner(s) or shareholders once all bills are paid. A business may have highly valued assets, but if it also has high liabilities, an owner may end up with significantly less than expected by the end of the process.
What’s Included in Owner’s Equity?
For privately owned businesses like sole proprietorships and partnerships, owner’s equity mainly includes the following categories, which either increase or decrease an owner’s overall equity:
Capital investments from the owner (increase).
Many business owners use their own money and assets (e.g., equipment or vehicles) to fund their businesses, especially when first starting up.
Retained earnings generated by the business (increase).
Once a business is up and running, retained earnings contribute to positive equity growth and increase the overall value of the company. This is an important measure because it’s the capital available from the business’s operations that 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 take too much, it can push a business’s equity into negative territory. Businesses can recover from negative equity, but long-term negative equity is unsustainable because the 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, the business may not be able to survive. Continued losses erode equity unless changes are made or the business gets a cash injection to turn things around.
For publicly traded companies, which usually refer to owner’s equity as shareholders’ equity or stockholders’ equity, several additional types of transactions can raise or lower equity and must be reported on the company’s balance sheet. These include:
Dividends and distributions (decrease).
Dividends and other financial distributions are paid from a business’s net income, which would otherwise go into retained earnings. Comparing retained 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 impair equity.
Outstanding shares (increase).
When a company sells additional shares to the public, it raises capital 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; any capital raised above the par value is classified as “other capital/additional paid-in capital (APIC)” and contributes to owner’s equity.
Treasury stocks (decrease).
When a company repurchases its stock from investors, the company-owned shares are called treasury stocks; they are listed as such on the balance sheet, and they reduce owner’s equity. But that may not be the end of a stock buyback story: By reacquiring stock, companies are spending money now to reduce their dividend payments in the future, which can lead to higher retained earnings — 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.” (If it doesn’t, there may be accounting errors or financial statement fraud.) 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 Manufacturing Co. is shown below. A real balance sheet would typically include more detailed breakdowns of assets and liabilities.
RCL Manufacturing Co.
Balance Sheet as of 31 December 2021
|Property, Plant & Equipment||$400,000|
|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 liabilities from assets yields owner’s equity of $285,000. At the bottom of the balance sheet, the owner’s equity section includes earnings, owner’s contributions/draws and any equity from companies the parent company has a minority interest in — also adding up to $285,000. These figures must match — “balancing” the accounting equation — before the business can close its books for the period ending December 31, 2021.
Statement of Owner’s Equity
A statement of owner’s equity is a more detailed document than the equity section of the balance sheet, and it depicts how equity changes over a period of time. For sole proprietorships and privately held businesses, the statement of owner’s equity shows the equity at the beginning of the time period, net income, any additional investments or withdrawals by the owner(s) and any non-cash contributions, such as equipment. The statement of equity may also show nonrecurring factors, like gifts or forgiven debts. These figures should match the equity total on the balance sheet.
If a previous period’s books have been closed and an adjustment needs to be made — for example, because of mathematical errors, misapplied accounting rules or a company migrating from cash-basis to accrual-basis accounting — “prior period adjustments” may appear in the statement of owner’s equity.
Below is a sample of a statement of owner’s equity showing an expansion of equity during the period 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|
|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 fictional public company, “RCLCorp.” Statements of shareholders’ equity show beginning/ending equity and net income, as well as dividends, additional paid-in capital and stocks.
Statement of Shareholder's Equity 11/30/21 - 12/31/21
|Beginning Equity As Of 30 November 2021||$2,300,000|
|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 the equity in the company to show the business’s value. Its assets include a fleet of trucks, repair equipment and a parking garage. Its liabilities include vehicle loans, credit card debt, 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 and wants to know how much equity is in the business. The owner lists the values of the company’s assets — property, equipment, inventory, accounts receivable (AR) and cash — and liabilities — mortgage, line of credit debt, tax liability, 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 a company’s market value — in fact, equity is usually lower than a business’s fair value, which is the estimated price that both a seller and buyer agree is “fair.” Mainly, this is because accounting rules require that assets be recorded on the balance sheet at the lower of either the historical cost — the original cost the asset was acquired for — or the net realizable value (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 brand strength, expected future returns, intellectual property, cash flow and anything else either party believes contributes to the business’s value. Other factors can contribute to a higher or lower sales price, too — like a company prioritizing a quick sale to stave off an impending bankruptcy. Because of the subjectivity that can accompany values like “brand strength,” a company’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 for the owners to invest more money in the business (in the case of a private company), bring on additional equity partners or authorize more shares of stock for sale (in the case of a public company). The second is to decrease a company’s liabilities, such as by refinancing high interest rate debt with lower rate options or reducing employee costs. The third, and most advantageous, way to increase equity is to increase profits, which then flow into higher retained earnings. This can be achieved by increasing revenue and/or increasing the efficiency of operations.
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Owner’s equity, the portion of a company’s value that owners or shareholders can claim, tells a lot about a business’s health, so it’s important to understand and analyze its components. If profits are the main driver of equity growth, rising owner’s equity can be a good sign of a financially healthy company. But if increased capital investment is the main driver, it could mean owners are trying to prop up a business that has insufficient cash and anemic profits. Details of owner’s equity can be found in the last section of a company’s balance sheet and in a separate statement of equity. Whether you’re a company owner or an outsider investor, owner’s equity is an important factor to help gauge a business’s net worth.
Owner’s Equity FAQs
What is equity?
Equity is the value remaining from a company’s assets after all liabilities have been subtracted. For example, if a business buys a piece of equipment valued at $20,000, but purchases it with a loan totaling $15,000, the equity in the equipment is the difference between 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. For example, if a transportation/delivery company has assets — a fleet of trucks, repair equipment and a parking garage — totaling $1,875,000, and liabilities — vehicle loans, credit card debt, a mortgage for the garage, payroll and taxes — totaling $710,000, the owner’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 the bottom of its 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, but owner’s equity is not itself an asset. Owner’s equity is calculated as the total value of a company’s assets minus the company’s liabilities. A company with higher assets than liabilities will show a positive owner’s equity.
Can owner’s equity be negative?
Yes. Owner’s equity is negative when a company’s liabilities exceed its assets, which can happen in a small business, for example, if the owner withdraws too much money from the company. Negative equity can create long-term problems for a business because it indicates that 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 commonly referred to as “shareholders’ equity.” Shareholders’ equity includes outstanding stocks, additional paid-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 business entity. For example, a stockholder with a 20% equity interest owns 20% of the business.