What is the Statement of Owner’s Equity?
The statement of owner’s equity, sometimes referred to as a statement of owner’s equity or owner’s equity statement, represents the value of a business after all its obligations have been met over a specified period of time.
This statement shows the movement of capital through a business and generally reflects the amount of capital the owner(s) has invested plus any profits the business generates that is in turn reinvested into the business.
This reinvested income is called retained earnings.
The statement of owner’s equity reports the changes in the owner equity for a specified period of time, typically at year’s end.
It is often used by mostly larger businesses as most small businesses report their retained earnings on their balance sheet.
If you do need to prepare one, it is usually prepared after the income statement because the net income or net loss for the period must be reported on this statement.
Similarly, it is prepared before the balance sheet, since the owner’s equity at the end of the period must be reported on the balance sheet.
Because of this, the statement of owner’s equity is often viewed as the connecting link between the income statement and balance sheet.
What is the Statement of Owner’s Equity Used For?
This statement can show the financial health of a business and whether that business has sufficient cash flow to fund its own operations without the aid of outside investment. In the exception of a business that is quickly growing and the owners have to invest capital to fund additional inventory, accounts receivable, wages, etc, if a business is unable to show it could financially support itself without capital infusions from the owner, creditors would be unlikely to loan the business money.
How do you Calculate the Statement of Owner’s Equity?
The statement of owner’s equity is commonly calculated by referring to the balance sheet and income statement during a specific period of time. The income statement provides information about the net income or losses of the business, while the balance sheet will provide the information regarding owner contributions and draws.
To calculate the statement, the beginning balance is needed to start and is obtained from the previous periods ending equity balance. Income and owner contributions are added to the beginning balance total, while business losses and owner draws are subtracted. This sum is the ending equity balance.
Beginning equity balance
+ Income earned
+ Owner contributions
– Losses incurred
– Owner draws
= Ending equity balance
Example of a Statement of Owner’s Equity
For this example, XYZ Inc. has $5,000 of capital at the beginning of the period. The owner, Jane Smith, added $1,000 of cash to paid-in capital and the business earned $2,000 from sales. The owner also withdrew $2,000 to pay for personal expenses. The resulting statement of owner’s equity shows an ending capital balance of $6,000. The ending equity balance will be carried forward to the following period and become the beginning balance.
We also have a free Excel template to download for the statement of owner’s equity.
The statement of owner’s equity is a powerful statement that draws on multiple financial statements to gauge the financial health of the business. This is one calculation that many small business owners overlook as they don’t understand the value of monitoring it to assess changes over time.
Banks, individuals, shareholders and other interested parties base their decisions to invest in a business on its ability to generate profit and maintain stability. Financial statements are essential to evaluating a firm’s management of assets, liabilities, income and expenses. The balance sheet and income statement are examples of financial statements often reviewed prior to making investment decisions.
Balance Sheet: Assets
The balance sheet summarizes the values of the items a business owns and owes as of a specific date. A balance sheet has three areas: assets, liabilities and shareholder’s equity. Assets are located on the left side of the balance. Assets represent the items a business owns and are listed as either current or fixed. Current assets represent cash and other assets that will convert to cash within 12 months. Examples of current assets include inventory, accounts receivable and current notes receivable. Fixed assets represent physical assets like vehicles and equipment; and nonphysical assets like trademarks and goodwill.
Balance Sheet: Liabilities and Shareholders' Equity
Liabilities and shareholders' equity are located on the right side of the balance sheet. Liabilities represent a business’ current and long-term debt. Current liabilities reflect items due to creditors in less than 12 months, whereas long-term liabilities are due in 12 months or more. Current liabilities include accounts payable and current payments due on long-term liabilities. Long-term liabilities include mortgages, bonds and notes payable. The shareholders’ equity section is located under liabilities on the balance sheet. Shareholders’ equity, located underneath liabilities, represent shareholders’ ownership interests in a business. Major components of shareholders’ equity are paid-in-capital, retained earnings and common stock.
Income Statement: Single-Step
Income statements reflect a business’ revenues and expenses during a certain period of time. Revenues represent the inflows of cash from the sale of products and services, whereas expenses represent outflows of cash related to revenues. Income statements are prepared in either single-step or multistep format. Single-step income statements groups and adds revenues from all sources in one section and groups and adds all expenses in one section. Total expenses are subtracted from total revenues to yield net income. The single-step income statement is useful for financial statement users seeking simplicity when trying to determine a business' earnings and expenses during a specific time period.
Income Statement: Multistep
Multistep income statements are complex because gross profit, which is sales minus cost of goods sold; operating expenses associated with revenue activities; and other income and expenses such as gains, losses and investment income and expenses, are grouped into individual sections. Each section is subtotaled to yield the income before taxes. The income before taxes is subtotaled, and the income tax expense is subtracted to yield net income. The multistep income statement is useful for financial statement users interested in analyzing the trends of a business' operating and nonoperating revenues and expenses.
If the total assets on the balance sheet do not equal the sum of the total liabilities plus shareholders’ equity, information is missing or calculated incorrectly. When choosing an income statement format, the single-step or multistep format may be used because both methods should result in the same amount of net income.
- "Fundamentals of Corporate Finance"; Stephen Ross; 2008
- “Intermediate Accounting”; David Spiceland; 2009
About the Author
I have over eight years of experience in litigation support and accounting. I received a Bachelors of Business Administration in Accounting from Florida Atlantic University in May 2009 and a Master of Science in Accountancy from the University of Phoenix in August 2011. Currently, I am studying for the Certified Public Accountant (CPA) exam.
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