How to calculate and increase owner's equity
Owning and running a business isn't easy. Aside from your initial investment, you may have to pump in extra capital and resources, not to mention your time and energy.
But if all goes to plan, you still have your owner’s equity — your share of the business assets, minus any outstanding debts.
In this guide, we’ll define owner's equity and explain how to calculate it. We’ll also explain the statement of owner’s equity and how it ties into your balance sheet. Then, we’ll show you how to increase your owner’s equity.
What is owner’s equity?
Owner’s equity represents the amount of money that a company would return to the owner after deducting all liabilities from the total assets. In other words, it’s the net worth of the business:
Owner’s Equity = Total Assets – Total Liabilities
For example, if a company's goods are valued at $750,000 and their total liabilities are $350,000, the owner’s equity is $400,000.
What are the main components of owner’s equity?
The main components of owner’s equity in a sole proprietorship include:
Original money invested by the business owner
Plus subsequent profits of the business
Minus money owed to others
Minus any distributions to the owner
If a business is structured as a corporation rather than a sole proprietorship, equity may also include accounts like:
Additional paid-in capital
How do you calculate owner’s equity?
You calculate owner’s equity by deducting the total business liabilities (such as wages, salaries, loans and debts) from the total business assets (including property, equipment, inventory, capital goods and retained earnings).
Here’s an owner's equity example:
Suppose John owns the company Entertainment Productions.
The end of the financial year balance sheet shows the company owns land worth $40,000, buildings worth $20,000, equipment worth $15,000, inventory worth $6,000, debtors of $3,000, and cash of $15,000.
Also, the company owes $20,000 to the bank for a loan, $6,000 to creditors, and $4,000 for wages and salaries.
Here’s how to calculate owner’s equity:
OWNER’S EQUITY = Total Assets – Total Liabilities
Assets = Land + Buildings + Equipment + Inventory + Debtors + Cash
i.e: $40,000 + $20,000 + $15,000 + $6,000 + $3,000 + $15,000 = $99,000
Liabilities = Bank loan + Creditors + Wages and salaries
i.e: $20,000 + $6,000 + $4,000 = $30,000
Owner's equity = $99,000 – $30,000 = $69,000
So, John’s equity is $69,000.
What's a statement of owner’s equity?
A statement of owner’s equity details the changes to the owner’s capital account over a specific timeframe or accounting period, such as:
The opening balance of the owner’s capital account
Gains in equity from profits or capital contributions
Reduction in equity from losses or capital distributions
The closing balance of the owner’s capital account
The statement of owner’s equity is one of four key financial statements that’s usually generated after the company’s income statement.
It indicates the company’s overall financial health and stability. And it tells the owner whether they need to invest more capital to cover any shortfalls or if they can draw more profit.
The closing balance on the statement of owner’s equity should correspond with the equity accounts shown on the company’s balance sheet for that accounting period.
How does owner’s equity flow through your business?
The value of the owner’s equity increases when the business generates more profits from increased sales or decreased expenses, or the owner or owners (in a joint partnership) contribute more capital.
The value of the owner’s equity decreases when the owner withdraws funds or takes a loan (recorded as a liability on the balance sheet) to purchase an asset for the business.
(Note: Any withdrawals are considered capital gains and may be subject to capital gains tax depending on the amount withdrawn).
The value of owner’s equity may be positive or negative. For example, a negative owner’s equity arises when the total liabilities exceed the total assets.
Also, the owner's equity could change if the value of assets changes relative to the value of liabilities, share repurchase and asset depreciation.
How do you record owner's equity on the balance sheet?
At the end of the accounting period or fiscal year, you’ll record the owner’s equity on the balance sheet.
The balance sheet details the assets, liabilities and the value of the owner’s equity. It’s called a balance sheet because both sides balance out — i.e. the assets must equal the liabilities plus the owner’s equity.
Assets are on the left side of the balance sheet; liabilities and owner’s equity are on the right. Since the owner has both contributed capital to the business and made withdrawals, the owner’s equity is always a net amount.
On the balance sheet of a sole proprietorship or partnership, equity is indicated as the capital account of the owner or the partners. It also shows the amount withdrawn by the owner or partners during the accounting period.
In addition to the balance sheet, businesses also have a capital account that shows the amount of equity contributed by owners and partners.
How does your business structure impact owner’s equity?
The way you structure your business impacts the owner’s equity. For instance, if you’re a sole trader, you’re legally responsible for everything, including the equity. On the other hand, partnerships and corporations typically have multiple owners who share responsibilities and equity.
Under this form of private ownership, one person owns the company and all the equity.
A partnership is a business with two or more owners. Each partner has a separate capital account that includes their investments, withdrawals and proportionate share of the company’s net income or net loss. So the owner’s equity is the sum of all the partners’ equity.
Net earnings are typically divided between business partners based on their ownership percentages.
Like partnerships, corporations usually have multiple equity owners or shareholders. The main difference is that corporations provide owners with legal liability protection, facilitating the transfer of ownership rights.
Shareholders, also called stockholders, are investors who purchased shares of stock in a company, thereby becoming owners of that company. As there’s no limit to the number of shareholders, the owner’s equity of a corporation is referred to as the aggregate shareholders’ equity.
After shareholders are paid their dues at the end of an accounting period, the remaining funds — called retained earnings — can then be reinvested into the corporation.
How do you increase owner's equity?
If you want to increase your owner’s equity, you’ll need to:
Lower your liabilities
Pay off debts
Reduce operating costs
Increase profit margins
Lower your liabilities
One way to lower your liabilities is to reduce your repayments and debt by refinancing existing loans at a lower interest rate.
Pay off debts
Repaying any accumulated debt will help you reduce your liabilities considerably. You can do this by paying more than the minimum balance on any loans. For example, if you have a loan for equipment, you could increase your monthly payments to reduce the outstanding capital and interest quicker.
Reduce operating costs
You could reduce operating costs by using more cost-effective products and machinery, streamlining business processes or reducing inventory costs. You could also monitor your business expenses to determine where you can spend less.
Increase your profit margins
You can increase profitability by selling more of your product or service. Likewise, raising prices or reducing your operating costs will automatically increase your profit margin.
Stay on top of your financials with MYOB
If you’re a business owner, you’ll want to keep tabs on the value of your owner’s equity: the amount of money due to you after deducting all your liabilities from your total business assets.
You can stay on top of your financials, including your owner’s equity, with online accounting software from MYOB.