What is Owner's Equity?

Owner's Equity on a Business Balance Sheet

Owner's Equity in a Business
Owner's Equity in a Business. Christian Baitg/Getty Images

As a small business owner, you are in a special circumstance of ownership. You own everything in the business except what you owe to other people. That's great, but do you really know how this ownership (called "equity") works? This article explains the concept of owner's equity and why it's important for you to know about it. 

What Does Equity Mean? 

The term "equity" means value or worth. It can also mean ownership.

In a general way of looking at equity, consider the value of something and how much is owed on that value. What's left over is equity. For example, equity in real estate means the part of the value of a piece of property that's not the loan amount. So, if a property is valued (appraised) at $100,000, and the loan amount (the current principal) is $80,000, the equity is $20,000. 

What is Owner's Equity? 

Owners Equity is am owner's ownership (equity) in the business, or the amount of the business assets owned by the business owners. Another way to look at this concept is to say that owner's equity in a business is the amount the owner has invested in the business minus any money the owner has taken out of the business in the form of a draw (not as salary). 

You can find the amount of owner's equity in a business by looking at the balance sheet. On the left are assets (the value of what the business owns).

On the right at the top are liabilities (what's owed by the business) and owner's equity (what's left over). See below for a more complete explanation of the balance sheet. 

Equity Interest

An equity interest is an ownership interest in a business entity, from the concept of equity as ownership. Shareholders have equity interest; their purchase of shares of stock in the corporation gives them a share of the ownership of the business.

Equity interest is in contrast to creditor interest from loans made by creditors to the business.

How Does Owner's Equity Get Into - and out of - a Business? 

Owner's equity is increased by (a) increases in owner capital contributions, or (b) increases in profits of the business. This is oversimplified, but basically the only way an owner's equity/ownership can grow is by investing more money in the business, or by increasing profits through increased sales and decreased expenses.

If a business owner withdraws money from owners equity, the withdrawal is considered a capital gain and the owner must pay capital gains tax on the withdrawal.

Business Ownership - Capital Accounts

Each owner of a business has a separate account (called a "capital account") showing his or her ownership in the business. The value of all the capital accounts of all the owners is the total owner's equity in the business. 

For example, let's say Tom begins a business and puts in $1000 from his personal checking account and a computer valued at $1000. This $2000 amount is called a capital contribution, since Tom has contributed capital (in the form of cash and property) to the business.

The next month, Tom takes a draw from the business in the amount of $500.

So his net owner's equity is $1500 at the end of the second month. It is possible to have a net negative owner's equity, if the owner takes more money out of the business than he or she has contributed. 

How is Owner's Equity Shown on a Business Balance Sheet?

Owner's equity changes over time, and it is shown at the end of an accounting period (month, quarter, or year) on the business balance sheet.  

The calculation for owners equity is assets minus liabilities. In a simplified example, if the value of the business assets is $3,500,000 and the total business liabilities are $2,500,000, the owners equity is $1,000,000. The business balance sheet shows assets on the left and liabilities and owners equity on the right.

On the balance sheet, owner's equity is shown as a net amount at a specific moment in time (usually the end of a month, quarter, or year).

The net amount is because the owner has contributed to the business but he or she has also taken money out of the business. 

Owner's equity is expressed differently in each type of business:

  • In a sole proprietorship or partnership, it is expressed as the owner's or partner's capital account on the balance sheet. 
  • In a corporation, it is expressed as retained earnings, which is basically owner's equity kept in the business to be used for business growth. 

Read more about the difference between owner's equity and retained earnings.