Owner’s equity is an essential metric used to determine a company’s financial health. It represents the residual interest in the assets of a business after deducting liabilities. Simply put, it is the value that owners would receive if all assets were sold, and all debts were paid off.

Calculating owner’s equity is crucial for business owners, investors, and stakeholders as it allows them to evaluate a company’s financial position and make informed decisions accordingly. In this article, we will cover how to calculate owner’s equity step by step and provide an insight into its significance.

Step 1: Gather Financial Data

The first step in calculating owner’s equity is gathering relevant financial data. This includes information from the balance sheet, which outlines the company’s assets, liabilities, and equity. Essential components include:

1. Total Assets: The resources owned by a business that have monetary value.

2. Total Liabilities: The obligations and debts owed by a business.

3. Contributed Capital: The amount invested in the business by shareholders.

4. Retained Earnings: The accumulated profits not distributed to shareholders.

Step 2: Calculate Total Assets

Total Assets include current assets (cash, accounts receivable, inventory) and non-current or long-term assets (property, plant and equipment). To calculate total assets, simply add up all your current and long-term assets:

Total Assets = Current Assets + Non-Current Assets

Step 3: Calculate Total Liabilities

Total Liabilities comprise both current liabilities (debts due within one year) and non-current or long-term liabilities (debts due beyond one year). To calculate total liabilities, simply add up all your short-term and long-term liabilities:

Total Liabilities = Current Liabilities + Non-Current Liabilities

Step 4: Calculate Owner’s Equity Using The Accounting Equation

The accounting equation illustrates the relationship between assets, liabilities, and owner’s equity:

Assets = Liabilities + Owner’s Equity

To find owner’s equity, simply rearrange the formula and subtract total liabilities from total assets:

Owner’s Equity = Total Assets – Total Liabilities

Step 5: Calculate Owner’s Equity Using The Statement Of Stockholder’s Equity

An alternative method to calculate owner’s equity is by understanding the statement of stockholder’s equity. This approach utilizes contributed capital and retained earnings as follows:

Owner’s Equity = Contributed Capital + Retained Earnings

In some cases, dividends paid to shareholders may also need to be accounted for while calculating owner’s equity. In such cases, owner’s equity can be calculated as:

Owner’s Equity = Contributed Capital + (Retained Earnings – Dividends Paid)

Conclusion

Understanding and calculating owner’s equity provides valuable insights into a company’s financial health. It helps business owners manage their operations more efficiently, investors to assess the company’s value, and stakeholders to examine the risks involved in investing or lending money. By following these steps and using the accounting equation or statement of stockholder’s equity method, you can successfully determine your company’s owner’s equity.