Owners of small businesses try to stay on top of their companies’ assets, total debt load, and cash flow to keep realistic picture of how things are going. Sometimes, owners don’t have the clearest view of the situation, or the company’s fortunes have grown so far that one person (or a limited number of people) just can’t manage it on their own. A good accountant, or a good accounting firm, can help a business owner make the most of the owner’s equity present on the company’s balance sheets.
Small business owners often mistake one type of asset for another. Retained earnings, for example, are frequently either left out of the calculation for owner’s equity through innocence, or they’re treated as if they’re all that matters when making financial decisions. Both approaches are problematic, and each could lead to trouble without an alert accountant to catch the mistakes and explain where the owners have gone wrong. Plenty of business owners have also made the mistake of dipping into their business equity as if it was a second bank account, and then getting frustrated at slow business growth.
As a professional who understands the terms and conventions of business bookkeeping, it falls to you to educate your clients and point them toward more responsible money management. You can, for example, subtract the company’s liabilities from its owners’ investments, add in the retained capital, and be ready with an exact figure for how much the business is worth. Once you’ve figured that, you’re in a position to give the client useful guidance for how to handle the surplus.
For instance, if your client plans to extract some earnings as profit in a given quarter, you can show how a substantial debit from the company’s accounts might push the owner’s equity into negative territory. Instead of letting the client slide into dangerous red ink, you can walk the client through a calculation of total equity – not just the cash on hand – and encourage retaining some of the positive equity as cash on hand in case the company hits a rough patch and needs a capital buffer to get through a slow time. You can also encourage spending the money back into the business, so it becomes the owner’s investment for the next cycle’s equity calculation. A small surplus could pay down existing loans and high-interest debt, such as company credit cards. Once all that has been taken care of, you might be able to encourage the owner to go ahead and take profit if the owner’s equity is high enough to bear it.
What to Watch
Owner’s equity consists of all the owner’s capital invested in the firm, plus retained earnings, minus the company’s debts. As the accountant for a small business, you might be the only person who’s watching the cash accounts, total earnings and retained earnings, asset holdings, and other key indicators that a sole proprietor might not have the time to watch. That gives you the time and the space to devise good investments the owner just doesn’t have the time or training to think of alone.
Calculating an owner’s equity is easy enough for an accountant, but it can go right past owners whose talents lie elsewhere. Use what you know to track the real value of the company, offer sensible advice, and spur faster-than-ever growth for your client.