Understanding Equity
In financial accounting, owner’s equity consists of the net assets of an entity. Net assets is the difference between the total assets and total liabilities. Equity appears on the balance sheet (also known as the statement of financial position), one of the four primary financial statements.
In simplistic terms, Equity is the difference between what a business owns and what it owes. If you are just starting out in business and you withdraw $50,000 from personal savings and put it in a business bank account your Balance Sheet would show:
Assets
Cash in Bank $50,000
Total Assets $50,000
Liabilities: (None)
Equity
Owner Investment (or Capital Contribution) $50,000
Total Liabilities and Equity: $50,000
If you then spent $30,000 and borrowed $70,000 from a bank to purchase a building, your Balance Sheet would show:
Assets:
Cash in Bank $20,000
Building $100,000
Total Assets $120,000
Liabilities:
Mortgage Payable $70,000
Equity:
Owner Investment (or Capital Contribution) $50,000
Total Liabilities and Equity: $120,000
As a business builds Equity through investments and business operations, owners might payout monies to themselves as an Owner Distribution (or Draw) if a sole proprietor or single member LLC. If the business entity is a corporation it would be a Shareholder Distribution. And likewise, if the entity is a partnership or multi-member LLC, it would be a Partner Distribution.
It is important to be aware of the amount of Equity available for distributions. Talk to your accountant about how much money you can payout.
New business owners often take more money out than the business can afford, causing extreme and sometimes fatal (for the business!) cash flow problems.
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