Equity represents the ownership interest in a company’s business assets after deducting all debts and liabilities.
Primary Implication
Over the last three years, has the Equity value reported on your Balance Sheet increased or decreased?
If your equity has decreased, you have failed to own a business worth more today than in previous years. You would be better served to place your money with a bank to invest for you if you choose not to make the required changes in how you manage your business. If you don’t want to make the necessary changes, then it’s time to explore selling or closing your business before you further erode your equity position.
Overview
Equity is represented at the bottom of the Balance Sheet after reporting Assets and Liabilities. It represents the capital used by the business owners to generate income. The amount is calculated by deducting the book value of the assets from liabilities.
This third category on your Balance Sheet represents the amount of the funds contributed by the owners or shareholders, plus any additional investments by owners, into the business—less any amount that the owner draws, plus the Net Income or losses of the business recorded as Retained Earnings.
Put more simply, the accounting equation, Equity (or owners’ equity) is the difference between the value of the Assets and the value of the Liabilities of the business as shown below:
Assets – Liabilities = Equity
Subtract Liabilities from Assets; you get Owners’ Equity. If this final number is increasing year-over-year, then you are building the value of your equity. If it’s declining, then you are destroying equity. Mathematically, it’s as simple as that.
