Many small business owners invest their own money to help fund their startups. According to one study, 77% of small businesses rely on their personal savings for initial funding.
The initial funds you or others invest in your company help lay the foundation for your business’s equity. Your business equity represents ownership and the value of your business. Read on to learn more about what is business equity, how to calculate it, and the importance of equity in a business.
What is business equity?
So, what is equity in a business? Business equity is the value of your assets after deducting your business’s liabilities.
As a business owner, you have the right to all items of value within your company. And, you take responsibility for your liabilities. Measure your equity by looking at the relationship between your business’s assets and liabilities.
Your assets are items of value, such as property, inventory, trademarks, or patents. Assets can be tangible or intangible. Tangible assets are physical things you can touch, like a building. On the other hand, intangible assets are things you cannot touch, such as copyrights.
Liabilities are debts your business owes to another business, organization, employee, vendor, or agency. Typically, you incur these debts through regular business operations.
When you incur more liabilities, your equity decreases. And when you gain additional assets, your equity increases.
When your business’s total equity is a positive number, you have more assets than liabilities. And, more assets means your business is gaining value.
Equity can also be a negative number. When your equity is negative, you have more liabilities than assets and your business loses value.
Calculating business equity
To calculate small business equity, use the basic accounting equation:
Equity = Assets – Liabilities
After you calculate your equity, report it on your balance sheet. You can also utilize the formula to determine how much you need to have in assets or liabilities to reach an equity goal.
In addition to calculating equity, the accounting equation can be used to determine your total assets or liabilities by rearranging the formula:
Assets = Liabilities + Equity
Liabilities = Assets – Equity
Calculating business equity examples
Learn how to calculate business equity by reviewing the examples below.
Positive equity example
Say you own a clothing company. Your inventory, cash, and other assets equal $12,000. Your debts and liabilities add up to $5,000.
$7,000 = $12,000 – $5,000
You have $7,000 worth of equity.
Negative equity example
Let’s say your clothing company’s liabilities increase to $15,000. And, your assets remain at $12,000.
– $3,000 = $12,000 – $15,000
Your equity would decrease to a negative amount of $3,000.
Setting an equity goal example
Say you determine you want to reach a goal of $30,000 in equity for your clothing business. You currently have $15,000 in liabilities. To find out how much you need in assets to meet your goal, manipulate the formula:
Assets = Liabilities + Equity
$45,000 = $15,000 + $30,000
To reach your goal of $30,000 in equity, you must have $45,000 in assets and $15,000 in liabilities.
Owners and business equity
As mentioned, equity represents your ownership in a business. The number of owners in your company can affect your business equity.
Single owners assume total ownership of the business. If you’re a sole owner, you assume all equity.
If you share ownership with others, you split the equity depending on initial investment amounts and how much of the business each individual owns.
Record business equity information on your balance sheets. The way you record the information depends on the number of owners.
Equity balance sheet for a single owner
Again, if you’re the only owner, you assume all equity. Your balance sheet should look similar to the one below:
| Assets | Amount | Liabilities & Equity | Amount |
|---|---|---|---|
| Cash | $13,000 | Accounts Payable | $7,000 |
| Accounts Receivable | $5,000 | ||
| Total Assets | $18,000 | Total Liabilities | $7,000 |
| Owner’s Equity | $11,000 | ||
| Total Equity | $11,000 | ||
| Total | $18,000 | Total | $18,000 |
Equity balance sheet for multiple owners
Your business might have multiple owners. When this occurs, the equity section of your balance sheet differs a bit from a single owner.
Equity in multiple-owner businesses can change when an owner withdraws money or pays dividends to shareholders. You must individually track owner’s equity for income tax purposes.
A balance sheet for a business with several owners looks like this:
| Assets | Amount | Liabilities & Equity | Amount |
|---|---|---|---|
| Cash | $13,000 | Accounts Payable | $7,000 |
| Accounts Receivable | $5,000 | ||
| Total Assets | $18,000 | Total Liabilities | $7,000 |
| Owner’s Equity | |||
| Owner 1 | $3,000 | ||
| Owner 2 | $6,000 | ||
| Owner 3 | $2,000 | ||
| Total Equity | $11,000 | ||
| Total | $18,000 | Total | $18,000 |
In both examples, the business equity remains at $11,000. However when three owners invest money and split the equity, balance sheets require additional information for each owner.
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This article has been updated from its original publication date of July 10, 2013.
This is not intended as legal advice; for more information, please click here.