What is Owners Equity?

What is Owners Equity? | Accounting Smarts
Charles Hall

Last updated by

Charles Hall

on

June 10, 2022

It is important if you own a small business, in particular a sole proprietorship, that you understand how healthy your business is, by keeping an eye on your owner's equity.

It is important if you own a small business, in particular a sole proprietorship, that you understand how healthy your business is, by keeping an eye on your owner's equity.

Owner's equity is defined as the amount of money left over when the sum of total liabilities is subtracted from the sum of total assets. Another way to view this is the owner's initial investment minus any draws, plus the net income of the business.

Owner's equity is one of the markers used to assess a business's overall health and evaluate the organization's financial state. This can help owners make critical decisions about both the day-to-day operations and short and long-term business goals. By evaluating an organization's overall health, the owner can make decisions about hiring and staffing, company growth, and estimate the value of the company.

ShowHide

Table of contents

What is Owner's Equity?

Owner equity can also be described as a company's book value but not necessarily the market value of the business. As a business owner, having a good understanding of the company's financial status is necessary to make sound financial decisions, both large and small, for the company.

Additionally, for owners applying for grants or loans, banks and other financial organizations must have a clear picture of a business's financial health before approving loan requests.  Owners equity will be one number reviewed.

So, as a business owner, what is the best way to calculate owner's equity?

How Exactly is Owner Equity Calculated?

The formula for owner equity is simple and can be described as follows:

Assets - Liability = Owner’s Equity

However, it is important to make sure that all assets and liabilities are captured in the equation. The best way to get started is to make a list of all company assets and a second list of all company liabilities.

Company Assets

A Company's assets can be defined as anything that a company owns and may be broken down into current assets, fixed assets or long-term assets.

  • Current Assets-Assets that are expected to be sold, used, or exhausted within the coming 6-12 months. Current assets are readily available and can easily be converted to cash.

Examples of current assets are:

  • Any cash currently in the business accounts
  • Accounts receivable - any outstanding invoices, monthly payments from customers, income from selling goods or services
  • Any current physical inventory including raw material
  • Any additional liquid assets

Current Assets are important as they are a source of quick cash for a company and can be used to fund day to day operations, pay utility bills, and cover ongoing manufacturing expenses.

  • Fixed Assets-Long-term assets that a company acquires in the process of operating their business. These are not liquid assets and cannot be easily converted into quick cash. These are long-term investments.

Examples of fixed assets are:

  • Any business property - both building and land
  • Office furniture and office equipment
  • Computers and purchased programs
  • Any company vehicles

Fixed assets help secure the company's future, providing a place to work, the equipment or machinery necessary to run the business or manufacture a physical product.

  • Long-term Assets-another form of long-term asset may be a note receivable from a customer or a loan.  While these long-term assets eventually will convert to cash they are not available for general operations.

Company Assets - Tangible or Intangible?

Company assets are also tangible or intangible. Tangible assets are physical assets that a company maintains, such as:

  • Physical property - land, office building, manufacturing plants, etc
  • Equipment - computers, furniture, manufacturing machinery
  • Any current product inventory

Tangible assets are easy to recognize and place value upon, as they are physical property and can be easily valued. Companies can also have intangible assets, which do not physically exist but still provide company value.

It may be quite a bit harder to determine the true value of intangible assets, but they are equally important to the health of an organization.

Examples of intangible assets are:

  • Recognizable company identifiers, such as jingles
  • Any company branding
  • Copyrights
  • Patents
  • Trade secrets
  • Franchises

Both tangible and intangible assets are important to a company, and each provides value that can contribute to owner's equity. Here are some ways to compare and contrast tangible and intangible assets.

Compare/Contrast Tangible Assets Intangible Assets
Form Physical - can be seen, touched and evaluated by sight, stored. Are not physical, often considered intellectual property, can not be stored, seen, or touched.
Value and liquidate Easy to assign value and sell based on a variety of factors, including supply/demand, market rates, etc., size and material value Not easy to value or sell, as there is no physical representation, value based on competitive advantages, and other estimates. Much of the value is "perceived value."
Collateral Value Can be used for loans, and other collateral, as costs of materials, equipment, and property is measurable Cannot be used to secure a loan or be used as collateral since cost and value are not easily assigned and based on perceived market value and estimates.
Risks Risks can be physical, as assets can be stolen, damaged by fire, flood, or other acts of nature Risks primarily based on poor business decisions, selling patents, not securing copyrights, or selling rights prematurely
Examples Physical business, property, equipment, and in-house product stock on hand Company logos, jingles, copyrights, product patents, and consumer trust

Why are Fixed and Tangible Assets Important?

It is very important that a business, whether large or small, keeps an accurate list and estimated valuation of its fixed, tangible, and current assets. Knowing the true value of a business and maintaining an accurate listing of all tangible assets will allow a company to demonstrate its estimated worth easily.

This ability is necessary for expanding and growing the business, obtaining loans, and providing appropriate collateral to secure financing.

In many ways, creating both short and long-term business goals can be easier when the majority of a company's assets are tangible, whether fixed or current. By tracking sales or monthly accounts receivable and estimating supply vs. demand, companies can set new sales goals, develop new products, or plan an expansion.

With tangible assets, it is much easier to determine the necessary investment needed to meet both short and long-term goals, and if necessary, secure financing.

Businesses with a high percentage of tangible assets

There are certain businesses and industries that typically carry a larger than average percentage of tangible assets. Some examples are:

  • Automobile dealerships
  • Bookstores
  • Distribution centers
  • Manufacturing plants
  • Personal Esty-style businesses, such as jewelry makers, and other artistic pursuits
  • Small independent retail shops
  • Technology production
  • Utility Companies

Whether small or large, companies such as these are dependent on a high percentage of tangible assets. Any net profit or owner's assets are built on product sales or product manufacturing, or in the case of distribution, supply and speed.

Why are Intangible Assets Important?

While much harder to value, intangible assets can be as valuable or even more valuable than fixed and tangible assets. For example, product patents ensure that other companies cannot make or produce the same product or provide an identical service to customers.

Copyrights for popular songs or marketing trademarks, such as the wildly popular "Where's the Beef" for Wendy's in the 1980s, can make a company or brand immediately recognizable.

Intellectual property is also considered an intangible asset. There are some industries, such as the dot.com industry and other tech arenas, where intellectual property and intangible assets are very common. It is hard, especially in the case of a start-up, to value intangible assets, so having outside investors or other cash flow sources is important, as intangible assets cannot be used to secure collateral.

Businesses with High Percentages of Intangible Assets

Due to the nature of the businesses, some industries have a high percentage of intangible assets, making it harder to truly estimate or calculate owner's equity.

Examples of companies with plenty of intangible assets are:

  • Education
  • Entertainment
  • Healthcare
  • Incorporated Youtubers, and other web-famous individuals
  • Technology R & D

Examples of Valuable Intangible Assets

As mentioned earlier, in many cases, while it is hard to place a dollar figure on it, intangible assets can be even more valuable than tangible assets. This is particularly true with consumer brands that are well known based on their logo, reputation, and consumer trust.

Consumer trust is a huge determining factor in estimating the value of intangible assets. It can increase the estimated worth of a company and its overall net profit or equity in many cases.

Some real-world examples of highly valuable intangible assets are:

  • The brand name Coca-Cola
  • The licensing for the use of Disney Characters
  • The copyright for many Beatles songs
  • The Nike Logo
  • The McDonald's Golden Arches

This is all considered intangible or intellectual property. While they cannot be evaluated in the same way a house or a business can, due to the overall recognizability and success of the items listed above, estimates can be made on the amount of money that will be generated by these assets over time.

Building Equity in a Business

After identifying various forms of assets and their importance, the next step is to increase business assets and build equity in the business strategically. While the strategy may differ somewhat based on several factors, such as company size, or type of business, there are universal tips to increase or build equity in business across the board.

Whether a business is a sole proprietorship, or a large, publicly owned corporation, there are strategic ways to build equity that work for everyone, such as:

  • Build a recognizable brand
  • Build brand value
  • Develop strategic partnerships
  • Find new and innovative marketing channels
  • Reinvest in the business
  • Strategically manage business capital

Building a Recognizable Brand

Building a recognizable brand can take a little time, but there are things that can help the process. While some popular brands today have built a reputation over many years, such as companies like State Farm Insurance or Coca-Cola, there are steps that companies can take that will help them build a brand quite effectively.

  • Be customer-centric - In today's marketplace, whether providing products or services, customers have various choices, and they can all be found at their fingertips online. Often the differentiator between two, or more companies, is the customer experience. Customers remember when they are treated well, and providing a positive customer experience helps to build brand loyalty
  • Create a catchy slogan or recognizable or descriptive name - Catchy titles or brand names, as well as creative taglines, can all help make a brand more recognizable to consumers. Some catchphrases are synonymous with specific brands, so it is important to capture and keep customer interest. A descriptive name or logo or a catchy or funny tagline can help.
  • Define your target audience - A company needs to identify its customers. To whom are their products/services catered? What need is this product or service fulfilling? By identifying the customer and the need being fulfilled, branding and marketing can be developed to appeal to those specific consumers.
  • Create a good story - Good branding is developed by identifying the target audience and their specific needs, then building the brand message that appeals to those customers. Identify what the target customer values, and build a brand narrative around the same values.

Strategically Manage Business Capital

Particularly when starting out, businesses should keep expenses as low as possible and manage money very carefully. Some tips for newer or growing businesses include:

  • Hire help only when absolutely necessary
  • Keep expenses low - work from home if possible
  • Maintain a close eye on all monies coming in and out of the business account.
  • Keep debt low while developing a brand and marketing strategy.
  • Spend money wisely - if it's not an absolutely necessary expense, hold off on spending.
  • Develop operating capital, for example, through crowdfunding or investors

Find Innovative Marketing Channels

Years ago, marketing a business was simple. Ads consisted of print advertisements, or TV and Radio spots, and advertisements were ½ page or full-page ads, or a 60-second spot in the middle of a television or radio program. Today, marketing is much more strategic.

Blogs and YouTube videos are used to push product and entertain all at once. Innovative business owners are finding ways to connect with their customers on a personal level.

Social media platforms, such as TikTok, Instagram, and others, have become popular showcases for small and developing businesses. Finding ways to use social media as a marketing tool while connecting to an audience is the new favored marketing tool of the internet age.

Develop Strategic Partnerships

For young businesses, strategic partnerships can really help boost customer base and name recognition and help the company reach a wider audience. A great way to build partnerships is to join small business organizations online and local.

Connecting with other companies that share a customer base can be helpful when developing a marketing strategy and connecting with consumers.

Valuable strategic partnerships include:

  • Companies that provide complementary or related services or products
  • Connect with peer mentors - online or in person, individuals with industry experience who are willing to share tips and experience
  • Distribution partnerships - if selling products, build relationships with small local businesses that may be willing to carry your product.
  • Money manager - Not every partnership is designed to increase the customer base. Having an outside money manager is vital. Let a money manager use their expertise to manage the financial aspects of the business.

Reinvest in the Business

As a business begins to turn a profit, it can be tempting to see that profit as income and that income as a measure of success. However, particularly in the first 18 to 36 months of a new business, reinvesting profits into that business can make the difference between success and failure.

Reinvest in the business by:

  • Developing new marketing channels
  • Getting improved or efficient equipment
  • Hire Hiring staff
  • Investing in business real estate
  • Investing in tech solutions that make managing business easier

Build Brand Value

While there are many ways to build brand value, the most effective strategies involve customers! Finding out what customers like, don't like, want, or don't want, can help build brand value tremendously. Connect with customers via a customer survey. To improve response rates, offer free products or services to one lucky responder.

Finding out what is important to a company's customer base is the first step in building brand value.

The steps to building brand value with customers include:

  • Identifying what customers like and don't like about the company/product
  • Recognizing the needs of the customers and be flexible and willing to meet those needs
  • Remaining trustworthy - respond to customer complaints, provide meaningful solutions
  • Continuing to elicit feedback from customers and other industry experts

Your Overarching Goal

The goals for all small businesses and sole proprietorships are to build a successful business, create a viable revenue stream and grow the company accordingly. To remain viable, regardless of the consumer climate, it is important to manage finances effectively, keep a close eye on net profits and owner equity, and reinvest in the business as much as possible, particularly during the first 36 months.

Understanding the basics of equity, assets, and how to build an effective brand are the first steps in creating long term success and increasing net profit and overall owner's equity.

Charles Hall

Charles Hall

Charles has spent 25 plus years in the world of accounting and business. His experience includes working as a CPA/Auditor international accounting firms. He has worked as a controller and as a COO for small to medium sized companies.

Learn more about Charles Hall