Owners’ Equity represents the residual interest in the assets of a business after deducting liabilities, reflecting the owners’ investment and the accumulated profits or losses of the business.
Primary Implication
The business results reported on each Balance Sheet establish how well ownership is doing to earn returns on their business investment. The difference between their Retained Earnings less Distributions less Opening Balance less Paid-In-Captial will either be greater or less. A business owner on their way to achieving financial freedom will see significant growth in Retained Earnings. Those who don’t, won’t achieve financial freedom through business ownership. It’s this black and white.
Overview
Owners’ Equity is the amount of money invested in the company by its owners to start the business. It represents the initial ownership interest or claim of a holder of common stock (ordinary shares), and some types of preferred stock (preference shares) of a company.
Ultimately, Owners’ Equity represents the monies available for the owner(s) after everyone else has been paid. It is termed a Liability because it is an obligation of the company to its owners for their investment in the business—minus the owner’s draws or withdrawals from the business, plus the Net Income (or minus the net loss) since the business’s launch.
Mathematically, the amount of owner’s equity is the amount of assets, minus the amount of liabilities. Another way to consider Owners’ Equity in a business is the financial value of the business to a prospective buyer. Viewed in this way, owners’ equity would not be considered a recordable value until the business has been sold—yet, ultimately, this value helps determine what the business is worth to you, based on what the buyer is prepared to pay. Unfortunately, this amount is rarely what you think your business is worth.
To appreciate how well you are converting the assets of the business into sales at a profit that increases Retained Earnings and thus Owners’ Equity consider the gap between your initial investment in your business and the total Equity reported on the Balance Sheet. Is it a large or small gap? If the initial amount invested is less than what is reported as Total Equity, then you have lost money on your investment. If the gap is small, what are you prepared to do differently today so that by the end of the year, you have increased the value of your Total Equity?
Ultimately, your ownership of business assets comes down to the relationship between liabilities and equity relative to assets. The more equity, the more you own your money-making assets.
