Owner’s Equity

How to Calculate Owner’s Equity

The owner’s equity is a fundamental accounting concept that measures the value of an owner’s stake in their business (or “net worth”).

In short, owner’s equity represents the residual interest in a company’s assets after deducting all liabilities, recorded for bookkeeping purposes.

Therefore, the net difference between the total assets belonging to a business and total liabilities reflects the concept of owner’s equity.

Simply put, the owner’s equity is the remaining value attributable to the owner in the event of a hypothetical liquidation, in which the leftover funds are returned to the business owner.

From the perspective of the business owner—or in other circumstances, shareholders with a stake in the equity of a company—the owner’s equity is critical to continuously monitor in order to track the book value of their equity interest over time.

In particular, common shareholders in a corporation must constantly monitor the value of the issuer’s common equity because borrowing capital (or leverage), which is measured via credit ratios like the debt to equity (D/E) ratio, impacts on the return on their investment.

Not to mention, common equity is placed at the bottom of the capital structure, so if a corporation were to hypothetically default and become insolvent, the recovery rate (i.e. recoup the initial investment) is improbably, especially if there are multiple classes of stakeholders.

Owner’s equity is a metric that measures the book value of value (BVE)—in contrast to the market value of equity (or market capitalization, i.e. “market cap”)—so, the recorded balance is constant and updated periodically rather than constantly fluctuating in value.

Hence, the “Owner’s Equity” line item is recorded on the balance sheet of a company, akin to the “Shareholders’ Equity” line item.

The step-by-step process to calculate owner’s equity, at its simplest, is as follows:

• Step 1 ➝ Calculate Total Assets (Current + Non-Current Assets)
• Step 2 ➝ Calculate Total Liabilities (Current + Non-Current Liabilities)
• Step 3 ➝ Subtract Total Liabilities from Total Assets

What are the Components of Owner’s Equity?

The components of owner’s equity for a sole initial capital investments, retained earnings, and additional owner contributions, minus any withdrawals or distributions.

On the other hand, shareholders’ equity consists of items such as common stock, preferred stock, additional paid-in capital (APIC), and treasury stock.

Each component of owner’s equity—including the impact—is described in the following table.

Owner’s Equity Formula

The formula to calculate owner’s equity subtracts a company’s total liabilities from total assets.

Where:

• Total Assets ➝ The total assets of a company refer to the resources belonging to a company with positive economic utility.
• Total Liabilities ➝ The total liabilities are the unmet payment obligations owed by a company to third-parties, such as suppliers, vendors, and debt lenders.

The logic that underpins the owner’s equity formula is rooted in the fundamental accounting equation, , which states that total assets must equal to the sum of total liabilities and equity.

In short, the owner’s equity formula is derived by re-arranging the basic balance sheet equation to solve for shareholders’ equity.

However, the term “Owner’s Equity” is most commonly used in the context of a sole proprietorship—which is the simplest business structure—wherein the entity is managed by one business owner, like an entrepreneur.

While a generalized sweeping statement, the owner and the business can be perceived as “one and the same” in a sole proprietorship.

In contrast, the standard term used for limited liability corporations (LLCs) and corporations is “Shareholders’ Equity” (or ”Stockholder’s Equity”).

LLCs and corporations seldom use the term “Owner’s Equity” in practice — albeit, the two terms are practically the same conceptually.

The distinction in the usage of the term pertains more to the corporate structure of the business (and the applicable taxation policies).

The formula to calculate owner’s equity for a sole proprietorship equals the sum of the initial investment and cumulative profits earned to date, subtracted by the sum of any owner withdrawals and liabilities.

Where:

• Initial Capital Contribution ➝ The initial investment contributed by the owner of the business (i.e. funding source to get the business up and running)
• Cumulative Profits ➝ The accumulated profits retained by the business since the date of inception.
• Owner Withdrawals ➝ The discretionary funds taken out of the business by the owner.
• Liabilities ➝ The payment obligations owed to 3rd parties, such as suppliers and vendors.