The Value of Properly Tracking Owner’s Equity
One of the first things I chat about with new clients is Owners Equity. It’s an extremely important part of the financial equation, yet often I find it’s not being tracked accurately or even at all.
Also known as stockholder’s equity or shareholder’s equity, this important calculation is how you determine the owners’ rights to the assets of the business. While it’s a simple equation:
Assets – Liabilities = Owner’s Equity
Its accuracy relies on ensuring all assets and all liabilities are accounted for. Know which liability account we most often see as inaccurate?
Direct owners’ contributions into the business.
What personal expenses should you track?
That last run to Staples where you purchased a case of paper and some other office supplies? You know, the one where you forgot your business credit card, so you used your personal one…. That trip. Did you properly track that expense? How about the startup business buying equipment with personal funds because the business can’t afford to yet? Did you remember to save those receipts and track it in your books?
Not ensuring that you are accounting for every penny you invest in your business can have a drastic impact on your business reporting and your personal finances.
What is a Statement of Owner’s Equity?
To truly understand why tracking these expenses is so important, let’s talk about what the Statement of Owner’s Equity really is. Like all accounting reports, with this report, we can gain insight of the finances over a specific time period. In the case of the Statement of Owners Equity, we are able to see the details of the owner’s capital (equity) account including:
• Opening & Closing Balances for the time period
• Contributions (increases to the equity account)
• Losses & Distributions (decreases to the equity account)
Owners’ equity can be more simply defined as the amount of money invested by the owner in their business less any money the owner has taken out of the business. It is calculated by tallying up all the business assets then deducting all the liabilities.
Why this information is important:
As money paid into the business by an owner is a liability, it is very important to account for all investments to ensure this number is correct. It is equally important to properly track withdrawals from the business (paid to the owner) as these withdrawals lower the liability. For many small businesses, owners’ equity combines these personal investments into the company, along with the earnings the company makes over time.
This calculation is extremely important as it provides a clear picture into the value of the business at any point in time. The result of the calculation can be used in many important scenarios where insight is needed of the value and profitability of a business. By being diligent and tracking these figures, a company will have an accurate picture of their net worth and will be able to make more informed decisions as they will have a much clearer picture of the true financial health of their business.
Sometimes a quick glance at a company sales figures shows a company as profitable, but a deeper dive into the income sources reveals a substantial amount of owners contributions. Correcting the contribution account could potentially highlight a liability that wasn’t accurately accounted for. When this is tracked correctly, the profitability may decrease. Decisions on the path of the company can be made with full knowledge and understanding of the financial health of the business – decisions that may have been vastly different without the clearer picture.
What to do next:
• Take some time and review your personal finances.
• Make a list of things that you know you paid out of pocket for: We are huge fans of a shared spreadsheet for tracking as our clients can pop the transaction details onto the spreadsheet at any time for us.
• Ensure you maintain proper documentation: Receipts, invoices, sales slips – save any supporting documentation in the event of an audit as ALL business expenses could be reviewed, regardless of payment source.
• Give the list to your bookkeeper. We need it to properly track the expenses for you!!
• Do you best to not use personal accounts for business expenses and business accounts for personal expenses. Avoiding commingling as a practice is always a good rule to follow.