Owners’ Equity Definition
Owners’ equity is the total amount that the business owes to its owners (or if it is a legal entity, for its shareholders). It is also known as book value of a business. Essentially an organization owes to its owners, the initial amount of investment and subsequent gains and losses obtained by the business from its origination. If owners have withdrawn any amount from the business, that amount is also been adjusted accordingly. This investment and the gains and losses are represented by the assets and liabilities of the business. Therefore, owners’ equity ultimately represents the capital of the organization, which is theoretically available within the business to distribute for its shareholders.
How to calculate owners’ equity on a balance sheet
Calculating Owners’ Equity on a Sole Proprietor’s Balance Sheet
Owners’ equity represents the value that the owner can catch up after selling its assets and settling all the debts. This can be calculated by adding following values together.
Owners’ Equity = Initial Investment of the Owner + Donated Capital (If any) + Subsequent Gains – Subsequent Losses – Withdrawals by the owner
Calculating Shareholders’ Equity on an Incorporated Business’ Balance Sheet
Shareholders’ equity represents the value that remains within the business after liquidating all the assets and settling off all the debts. This remaining value is the amount that is distributed among the shareholders of the company. This can be calculated by adding together the balances of all equity accounts that appear in the balance sheet (Ex- common stock account, preferred stock account, retained earnings…etc. This can be simply depicted as follows.
Calculating Owners’ Equity on a balance sheet using Accounting Equation
This is an alternative approach to calculating owners’ and shareholders’ equity, using the values that appear on the balance sheet. This approach uses primary accounting equation to calculate owners’ or shareholders’ equity. This is a simple approach and can easily be applied to calculate both equity of sole proprietors and the shareholders of a company.
The accounting equation is,
Assets = Liabilities + Owners’ Equity
From this the formula to calculate owners’ equity can simply be derived as,
Owners’ Equity = Assets – Liabilities
The process to calculate owners’ equity on a balance sheet
This process involves three steps.
Step 01: Calculate the value of the total assets, both tangible and intangible. These asset values are calculated based on the current market value, not to the cost, with an adjustment for appreciation or depreciation.
Step 02: Calculate the value of total debts, both short-term debts and long-term debts.
Step 03: Subtract the value of total liabilities from the value of total assets. The answer may be positive or negative. If the value is positive, it is the amount that the owners or shareholders right. If the value is negative, it is the amount that the owner owes to the organization, in a sole proprietorship, and if it is an incorporated business entity, that is being obligated of the business itself.