How to Account for Owner’s Equity on Your Balance Sheet

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A balance sheet is one of the most important financial statements all business owners should be familiar with. This is where you would find out how much your business owns, as well as how much it owes — known as assets and liabilities in financial terms. But it also tells how much of the business you, or the owners, own. This is a concept known as owner’s equity.


Overview: What is owner’s equity?

Owner’s equity refers to the portion of a business that is the property of the business’ shareholders or owners. The simple explanation of owner’s equity is that it is the amount of money a business would have left if it shut down its operations, sold all of its assets, and paid off its debts.

Owner’s equity is more commonly referred to as shareholders’ equity, especially in cases where the company is publicly traded. But it’s important to note that these terms are essentially interchangeable.

In addition, owner’s equity is also commonly known as “book value,” especially when referring to a company on a per-share basis. For example, if owner’s equity in a company is $10 million and there are 1 million outstanding shares of stock, you could say that the book value per share is $10.

Finally, it’s important to note that owner’s equity is different from an owner’s draw, which refers to money that is actually paid to the owner(s) of a business.

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How to calculate owner’s equity

Think of owner’s equity in the context of owning a house. If you own a $500,000 house but owe $300,000 on your mortgage, the $200,000 difference is the equity in your home.

The same basic mathematical formula applies to a balance sheet, where you’ll find a company’s assets, liabilities, and a statement of owner’s equity. And here’s the basic accounting equation to know:

Assets – Liabilities = Owner’s Equity

So, the simple answer of how to calculate owner’s equity on a balance sheet is to subtract a business’ liabilities from its assets. If a business owns $10 million in assets and has $3 million in liabilities, its owner’s equity is $7 million.

In real-world situations, small business accounting software can help you calculate your owner’s equity.

Obviously, it gets a bit more complex than that. Assets are more than just physical property a business owns, and liabilities are more than just debts. We’ll go through an example in the next section but here are the main items that need to be included when determining the assets and liabilities of a business:

Business assets

While this isn’t meant to be an exhaustive list, and it’s certainly possible for the exact terminology you see to be slightly different, here are the most common types of assets you’ll see on a balance sheet:

  • Cash and cash equivalents: Actual cash in the bank as well as things such as short-term Treasurys and CDs
  • Marketable securities: Stocks and bonds and other investments that the business owns, which can be readily sold if needed
  • Accounts receivable: Money owed to the company
  • Inventory: Items the business owns that are available for sale
  • Long-term investments: Securities that cannot easily be liquidated within the next year
  • Fixed assets: Buildings, manufacturing equipment, and other tangible assets
  • Intangible assets: Assets that are not physical or monetary — intellectual property as an example — that can have significant value to a business
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Business liabilities

Just like the assets list above, this isn’t an exhaustive list of all liabilities a business could have, but here are some of the most common categories:

  • Business debt: Long-term debt and short-term debt (typically due within one year)
  • Accounts payable: Money the business owes to vendors
  • Pension liabilities: Money the business needs to pay into employees’ retirement accounts
  • Customer prepayments: Money the business has collected for goods or services it has not delivered yet
  • Deferred tax liability: Taxes that have accumulated but will not be paid for at least another year

Example of owner’s equity

To illustrate how owner’s equity works with a real-world example, let’s take a look at Apple’s (NASDAQ: AAPL) most recent balance sheet.

On the assets column, Apple’s breakdown is as follows:

Item

Amount ($ billions)

Cash and equivalents

$38.0

Short-term investments

$52.9

Accounts receivable

$37.4

Inventory

$4.1

Other current assets

$11.3

Property, plant, and equipment

$45.3

Long-term investments

$100.9

Other long-term assets

$32.2

Total assets

$323.9

Data source: Apple. Figures may not add exactly, due to rounding.

Now, let’s take a look at Apple’s liabilities:

Item

Amount ($ billions)

Accounts payable

$42.3

Accrued expenses

$1.4

Short-term debt

$5.0

Current portion of long-term debt

$8.8

Other current liabilities

$47.9

Debt

$113.1

Other liabilities

$53.9

Total liabilities

$258.5

Data source: Apple. Figures may not add exactly, due to rounding.

Subtracting the liabilities from the assets shows that Apple shareholders have equity of $65.4 billion.

It’s important to note when it comes to publicly traded companies that owner’s equity and market capitalization (market cap) are two very different concepts. Owner’s equity is simply the on-paper value of a company’s assets minus its liabilities.

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On the other hand, market capitalization is the total market value of a company’s outstanding shares. Apple’s current market cap is about $2.2 trillion, so investors clearly think Apple’s business is worth many times more than the equity shareholders have in the company.

Shortcomings of owner’s equity

Owner’s equity isn’t the same thing as the actual market value of a business. Depending on the circumstances, a business could truly be worth far more than its owners’ equity, as in the case of Apple, or if there’s something fundamentally wrong with a business, its true value could be less than the owners’ equity.

The reason for this is that there’s quite a bit of important information that a balance sheet and owner’s equity doesn’t tell us. For example, it doesn’t tell us whether a business is profitable or not, what its operating margin is, or whether it produces positive operating cash flow.

For this reason, owner’s equity is only one piece of the puzzle when it comes to valuing a business. And that’s also why a balance sheet is only one of three important financial statements (the other two are the income statement and cash flow statement). To truly understand a business’ financials, you need to look at the big picture, not just how much its theoretical book value is.


The bottom line on balance sheets and owner’s equity

Owner’s equity or shareholder’s equity is an important concept for all business owners and investors to understand, as it can show the actual intrinsic value and financial health of a business. Knowing the basics of how to read a balance sheet and calculate owner’s equity is an important skill for owners of businesses of all sizes, as well as for investors of public companies.

View more information: https://www.fool.com/the-blueprint/owners-equity/

Xem thêm bài viết thuộc chuyên mục: Blue Print

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