Business Plan Balance Sheet: Owner's Equity
Equity is the part of a business that the owner or owners actually own. Think of equity this way: Lots of people who say they own their homes really own just a piece of their homes, and banks or mortgage companies own the rest. The same is true for business owners and their businesses.
What’s more, the equity in your business might be distributed among a number of owners in all sorts of ways with various strings attached defining when equity can be sold or how it can be used. You may be the one-and-only owner of your company, or your company may be a publicly traded corporation owned by tens of thousands of investors.
Under any ownership structure, though, when you strip away all the complexity, owner equity comes from two basic sources of equity: money coming from outside investors and money generated from profits that are kept inside the company. These two forms of equity are called
Invested capital: Money invested in your company comes from various sources, including cash you put up as a principal owner of the business or cash you raise by selling small pieces of your company in the form of stock to outside investors.
Outside equity may be privately held, or, when your company is big enough, you may decide to go for an initial public offering (IPO) — making shares of your company available for sale on a public stock exchange. No matter how you exchange equity for cash, it’s all lumped together as invested capital.
Accumulated retained earnings: When your business turns a profit (meaning when revenues exceed all costs and expenses), you face the happy decision of what to do with the windfall.
You may decide to give some of it back to the owners and investors in the form of dividends. Or you may plow some of the profits back into the business so that you can grow bigger and, as a result, create more equity for everyone who has a stake in your company. Accumulated retained earnings represent all the profits you’ve poured back into your business.
Total owner’s equity is the sum of invested capital and accumulated retained earnings, which together equal the value of the part of the company that the owners actually own.
Total owner’s equity = Invested capital + Accumulated retained earnings