Owner’s equity seems self-explanatory, and to some extent it is. But understanding the details of this all important part of the small business balance sheet is key to determining your business’s value.
Simply put, owner’s equity is the total assets minus the total liabilities of an individual or a company. In other words, once all liabilities are paid, the owner’s equity is what remains in assets. Of course, if liabilities (or debts) outweigh the assets, there’s a negative ownership equity.
Owner’s equity, when referring to a company specifically, also goes by the terms net worth, net assets, or shareholders’ equity (or the shares of these funds spread among shareholders, if the company has any). Ownership equity can also be referred to as risk capital, liable capital, or just plain equity. This form of equity typically comes from two sources: initial and ongoing investments by the owner of the company, and the earnings the company takes in over time.
This definition is important because it gives a clear and true picture of what the business is worth. In a case where a business may fall on hard times (e.g., it fails to pay bills or it needs to be sold or go into receivership), the owner’s equity offers insight into the value of the company. The term owner’s equity, in fact, means that which falls to the owner after all other creditors have been paid, the last claim against assets.
Owner’s equity differs from book value. In accounting, book value, or carrying value, includes only tangible assets (the original cost of these assets minus any depreciation or amortization), not intangible assets or goodwill. Owner’s equity includes both tangible and intangible items, such as a company’s brand name, reputation, and goodwill from customers and vendors. Owner’s equity also includes accounts such as preferred stock, share capital, capital surplus, stock options, retained earnings, and treasury stock.
When a company is owned by shareholders, the term ownership equity can be substituted by shareholders’ equity, which again refers to the company’s assets minus its liabilities. If shareholders each have the same stake or holding in the company, they share equally in ownership equity; but this terminology can be more complex if there are different share classes or options among the shareholders, with differing shares in equity.
Various personal financial management packages, both software-based and online through a bank or a nonbank Web site, can offer business owners the tools to track their owner’s equity and give them a true insight of the value and ongoing profitability of their business. This is particularly helpful because by tracking the changes in ownership equity as a company tweaks its business model, changes its product and service makeup, or expands its operations, owners or shareholders can get a clearer sense of what factors contribute to the company’s overall net worth. For example, a particular course of expansion may add to a company’s short-term liabilities and costs but may offset that trend by contributing more to the company’s revenue as well as intangible assets, such as broadening its customer base and developing new revenue streams.
Karen Epper Hoffman writes about business, banking, and technology issues for a variety of trade and mainstream publications.