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Have you heard the old adage, "Make hay while the sun shines?" In simplest terms, the equity section of a balance sheet tells us exactly how much hay is in the barn.
This section of the balance sheet is usually the most confusing. Understanding it asks us to be a bit abstract.
Assets are straight forward. Liabilities are too. We know what we own, and we know what we owe.
Equity on the other hand is what our business is worth in accounting terms. (The equity section does not account for Goodwill that has been established.) To determine the true value of your business you would need to speak with a valuation expert.
In the simplest terms, equity accumulates the profit/loss throughout the life of the business, initial investments or injections and amounts withdrawn from the business. The exact way these are handled will depend on the type of entity.
Let's use an S Corp for example:
Equity will be comprised of the $10,000 you initially deposited, along with assets transferred into the business name. These first injections, along with others, are usually allocated between Common Stock & additional paid in capital. A CPA will help you with this determination, so don't worry about that. You will get expert advice in getting the allocations correct. It's only important to know WHAT these terms mean.
During the business' lifetime, it will generate either a profit or a loss, annually. The P&L will calculate this for us. Because the P&L is a partier and closes out at the end of the calendar/fiscal year - the net amount gets transferred over to the equity section into Retained Earnings to accumulate year after year and the P&L gets a fresh start at $0.
Because S corp owners are allowed to take distributions/draws, any amounts withdrawn will be deducted as a return of equity.
It will look like this:
I think it's a beautiful day for making hay!
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