Owner’s Equity: What it is and How to Calculate it
Owner’s equity is the value you arrive at when your business’ liabilities are deducted from your business’s total assets. Learn what owner’s equity is and how to calculate it here.
While you may need to take accounting classes to understand and do some business calculations, “business equity” or “owner’s equity” is a much easier concept to understand for any business owner willing to give it a try.
There are many misconceptions about what owner’s equity is, which has left many business owners confused. In this post, you will understand exactly what owner’s equity is and how to calculate it like an expert in no time.
Before you set off to find out what equity is and how to calculate it, you need to understand a few things first.
- Owner’s equity is an accounting perspective that measures your business’s value and not necessarily what your business or company is worth.
- There is a difference between market value and accounting value. You’ll get to understand better in a moment. Just make sure you Stick around!
- Are you thinking of selling your business or company in the future? Then, you should understand that there are other factors you should consider, as business equity shouldn’t necessarily determine how much you should sell your business. Brand awareness, business location, and some other intangible assets would make a better determining factor.
Now that you have a better understanding of what the owner’s equity is not, you may want to find out what owner’s equity is and how it is calculated.
What is Owner’s Equity?
Simply put, an owner’s equity is the value you arrive at when your business’ liabilities are deducted from your business’s total assets. That simple!? YES! It has never been hard. Owner’s equity is a less bothersome concept but still one of the most crucial accounting concepts you would ever learn as a sole proprietor.
If you have seen a sole proprietor’s balance sheet, then you would understand that an owner’s equity is among the three important sections contained therein. As a business owner, it is important to know and understand how to calculate an owner’s equity, and that’s exactly the essence of this post. To guide and accost you to becoming more knowledgeable in this regard.
Why is Owner’s Equity an Important Business Calculation to Know?
Among other reasons why the owner’s equity is an important calculation is that it can help provide you with a price for your business that is likely the liquidation value.
Perhaps, you need to get a loan or investment for your business at some point, then your owner’s equity at the year-end and the previous year is crucial.
Equity means that you have leftovers from your business’s activities after doing your tax and deductions. This can get you an advantage in benefiting from an expansion loan from a lender.
Is There a Relationship Between Owner’s Equity and Net Income?
Of course, there is a significant relationship between the two concepts. Your business’ equity will increase depending on the amount of your company’s revenue that is left over after deducting and paying all expenses.
Owner’s equity will increase when business assets increase if a company makes a profit and keeps some of that profit.
Likewise, an owner’s equity will also decrease if there is a decline in business profit.
How Do I Calculate Owner’s Equity?
Calculating an owner’s equity is no doubt one of the simplest business calculations you’ll ever do. Still, before you can make an accurate calculation, you’ll need to know your business’s assets, liabilities, and owner’s shares.
How to Calculate Net Asset Value?
- Sum up your business assets’ value: Let’s say you have office furniture, business machinery, and real estate; all these are tangible assets and should be summed up. If you spend $50,000 on real estate, $50,000 on equipment, and $50,000 on real estate, then you will have a total of $150,000 as your business assets.
- Calculate contra accounts on the businesses’ assets: Contra accounts mean that you should calculate bad debts, depletion, and depreciation of the company’s assets. In cases where you have assets with possibilities of getting a depreciation, you will need to calculate how much the value has dropped over time. For example, company machinery bought in 2015 would have depreciated by 2019. You need to calculate the value of depreciation and sum it up as your contra account. Let’s say you have a depletion of $5,000, depreciation of $15,000, and bad debts of $20,000. Then, your contra account will be $40,000.
- Calculate Net Asset Value: To calculate your business’ net asset value, all you need to do is subtract the amount of your contra accounts from the sum of your business assets. In this case, we have $200,000 as our total business assets and $40,000 as our contra account on those assets. Then, our net asset value will be $200,000 - $40,000, which will equal $160,000.
Therefore, your business’s net asset value is $160,000.
How to Calculate Owner’s Equity?
- Calculate Business Liability: Firstly, you want to make sure that your business’s liabilities are duly dated on the day of the balance sheet. Business liabilities are the financial obligations of a company. Examples of liabilities include customer deposits, salaries payable, or accounts payable, or interest tax payable.
Let’s say you have the following business liabilities; tax= $5,000, salaries= $10,000, loan= $3,000, and bills= $4,000. The sum of these values will be your business liability, and with these figures, you should have $22,000.
- Subtract Liabilities from Net Asset Value to Determine Equity: When you subtract the amount you have as your business liability from your net asset value, what you have is the equity of the business or owner’s equity.
Using the values from our previous examples; if your business has net asset value of $160,000, and a liability of $22,000, then, your owner’s equity will be; $160,000 - $22,000= $138,000.
How to Calculate the Equity of Individual Owners in a Joint Enterprise?
Calculating individual equity in a joint business is quite easy and straightforward to do. The total business equity should be divided by the percentage each owner owns in the company.
In a company where two partners have equal shares, the total business equity will be divided by 2. For example, each owner will receive $100,000 in a company where the total business equity is $200,000.
In a company where owner A has a share of 70% and owner B, a share of 30% and total business equity of $200,000. Owner A will receive 70% of the total business equity ($140,000), while owner B will receive 30% of the total business equity ($60,000).
Owner's equity is one of the many accounting concepts that every business owner must learn to calculate. If you have followed this post, then you should already know how to calculate your business' equity and should probably understand by now what your business is worth.
Owner's equity also referred to as net worth, equity, or net assets, is a crucial component of the three main aspects of a company's finances. Learning to calculate it accurately won't be a waste of time at all.