If your accountant generates periodic financial statements for your business, you may have noticed equity accounts on the balance sheet or seen a statement of equity. Equity accounts aren’t always intuitive or easy to decipher. To add to the confusion, terminology for these accounts can vary wildly. Put simply, they represent the assets you have invested in your business, so they’re important to understand and monitor.
If you’re a sole proprietor or a single-member LLC, you’ll see an “owner’s equity” or “member’s interest” account listed at the bottom of your balance sheet. This represents the cash or other assets that you have invested in the company. The value of this account is increased by capital contributions, like when you take money out of your personal bank account to use for business operations. It’s also increased by the amount of net income you earn each year. It’s decreased by any annual net losses and by any cash that you take out of the company for personal use, referred to as owner’s draws.
Partnerships and LLCs
Equity accounts in partnerships and multiple-member LLCs need to reflect the fact that multiple parties have equity in the business. To account for this, the equity accounts of each individual are often labeled. For example, a two-person partnership may list, “John Smith, Capital Account” and “Jane Doe, Capital Account.” As with sole proprietorships, equity accounts are increased by contributions and net income and decreased by net loss and draws. Net income and net loss will be allocated to each person’s equity account based on their proportional ownership or the percentages indicated in the operating agreement.
S Corporations and C Corporations
S corporations and C corporations list a few extra equity accounts on the balance sheet. Rather than “owner’s equity” or “partner capital,” the corporation’s accumulated net income is labeled as “retained earnings.” Net income increases retained earnings while net losses and stockholder dividends decrease it. The capital that stockholders have invested in the company is labeled as “paid in capital.” The equity section will also mention “common stock” or possibly “preferred stock,” which is capital the company received in exchange for issuing stock to stockholders. Each stockholder’s equity account usually isn’t labeled on the balance sheet but it may be broken down in the statement of equity if there are only a few owners.
Equity Accounts on the Financial Statements
Equity accounts show up on both the balance sheet and the statement of equity (also referred to as the retained earnings statement, an equity statement, a statement of shareholder’s equity, or statement of owner’s equity).
The sum of the equity accounts on the balance sheet represents the dollar amount of equity in the company at a certain moment of time. The basic accounting formula is assets minus liabilities equal equity, which means that the equity section of the balance sheet represents the assets your company holds net of any outstanding liabilities. You can also think of this as the company’s net worth.
The statement of equity, on the other hand, represents the changes in equity during the accounting period. This is where accounts like “dividends paid” or “owner draws” show up. You’ll know it’s a statement of equity if there’s a beginning balance and an ending balance. For example, a statement of equity for a sole proprietor may look something like this:
Owner’s equity, beginning balance: $50,000
Net income for the year: $10,000
Owner’s contributions: $5,000
Owner’s draws: ($2,000)
Owner’s equity, ending balance: $63,000
From this statement, you can see that the owner’s equity increased by $13,000 during the accounting period from net income plus contributions less the owner’s draws.