What is Equity in a Business?

Most small businesses are started with money invested by the owner. These funds can be categorized as Equity, specifically Owner’s Equity, in a business and are reported on a Balance Sheet.

Equity can also refer to the value of a business. For example, a business may have assets (items of value such as equipment and money) listed at $15,000 and liabilities (money owed, debt) of $11,000. This results in equity of $4,000 for the business.

Balance Sheet: Single Owner

Assets

Amount

Liabilities & Equity

Amount

 Cash  $10,000  Accounts Payable  $11,000
 Accounts Receivable  $5,000    
 Total Assets  $15,000  Total Liabilities  $11,000
     Owner’s Equity  $4,000
     Total Equity  $4,000
 Total  $15,000  Total  $15,000

Keep in mind that there could be multiple owners of a business who each invest money. When this occurs, the equity section of the Balance Sheet will look different, although the result is the same. Equity can also change when an owner withdraws money from the business, when dividends are paid to shareholders, and when retained earnings are included.

 

Balance Sheet: Three Owners

Assets

Amount

Liabilities & Equity

Amount

 Cash  $10,000  Accounts Payable  $11,000
 Accounts Receivable  $5,000    
 Total Assets  $15,000  Total Liabilities  $11,000
     Owner’s Equity  
     J. Smith  $500
     R. Wells  $1,500
     P. Brown  $2,000
     Total Equity  $4,000
 Total  $15,000  Total  $15,000

Keep in mind that there could be multiple owners of a business who each invest money. When this occurs, the equity section of the Balance Sheet will look different, although the result is the same. Equity can also change when an owner withdraws money from the business, when dividends are paid to shareholders, and when retained earnings are included.

In both examples above, the equity is $4,000; however, when three owners have invested money into the business, they each can have a line in the equity section of the Balance Sheet. It is important for owner’s investments to be tracked individually for income tax purposes. In large companies, it is acceptable to simply list Shareholder Equity as a combination of all investments, but a separate document would track the money invested, deducted, and gained by each shareholder.

The dollar amount of available equity also changes in the course of business. When more liability (such as a new business loan or more payroll) is incurred, equity can decrease. When assets increase (sales generate more cash or accounts receivable), equity increases.

When total equity is a positive number, the assets of a business are greater than the liabilities and the business has value. Unfortunately, sometimes equity can be a negative number. When this happens, the liabilities are greater than the assets, and the business is generally losing value.

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