If you’re a homeowner, you know about home equity: the difference between the current market value of a home and the outstanding mortgage balances and liens on the property. Your home equity represents the value of your interest — or ownership — in your home.
What is owner’s equity, then? It works the same way, but it’s about the value of your interest in a business you own or have a stake in.
What Is Owner’s Equity?
According to the Corporate Finance Institute, owner’s equity refers to how much of a company’s total asset value its owners (if the business is a sole proprietorship or a partnership) or its shareholders (if the business is structured as an LLC or a corporation) have a right to claim.
As the Farlex Financial Dictionary explains, owner’s equity can help determine the creditworthiness of an individual or a company, and it can be used to assess the value of a business when its owner or shareholders are looking to sell it.
How to Calculate Owner’s Equity
To calculate owner’s equity, first add the value of all the business’s assets, which include real estate, equipment, inventory, retained earnings and capital goods, the Corporate Finance Institute notes. Next, calculate all the business’s liabilities — things such as loans, wages, salaries and bills. Then deduct the liabilities from the assets. What’s left is the net worth, or how much equity the owner has in the business.
Expressed as a simple equation, it looks like this: Owner’s Equity = Assets – Liabilities.
If an owner puts more money or assets into a business, the value of the owner’s equity increases. Raising profits, increasing sales and lowering expenses can also boost owner’s equity.
On the other hand, if the owners withdraw cash from the business account or take out a loan to buy an asset, the owner’s equity decreases. If the liabilities are greater than the assets, the owner’s equity is negative.
How to Document Owner’s Equity
On the balance sheet of a sole proprietorship, the owner’s equity is recorded on the line for the owner’s or partner’s capital account. If the business is a corporation, owner’s equity goes under the heading of shareholder’s equity or stockholder’s equity on the balance sheet.
A separate document called a statement of owner’s equity — which is sometimes referred to as an equity statement, a statement of changes in equity or a statement of retained earnings — reports changes in the owner’s equity of a business. Profits, dividends and owner’s withdrawals are among the things that can change owner’s equity, and they must be reported on a statement of owner’s equity, the Corporate Finance Institute notes.
As a small business owner, understanding owner’s equity and knowing how to calculate owner’s equity and record it on an accounting statement will help you track the net value of your company and its assets. When you have that information at your disposal, you’ll be prepared to prove that your business is healthy to a potential lender or buyer.