Accounting Primer: Equity and Net Worth

Equity

Equity is a term that is very much dependent upon the context in which it is used. On a balance sheet it is the difference between Liabilities and Assets. As a description of investment options it describes securities that represent ownership versus securities that represent debt. In the realm of real estate it represents the value of a property in excess of the debt associated with that property. In a court of law it represents a concept of fairness.

On the Balance Sheet Equity is represented by total assets minus total liabilities. Equity or Net Worth is the most patient and last to mature source of funds. It represents the owners’ share in the financing of all the assets.

  1. Capital Stock: The amount invested by shareholders to establish the business. This is the actual amount paid directly to the company by shareholders when they purchased the original shares. This does not include subsequent
  2. Treasury Stock: Often referred to as Treasury Shares. The amount invested by the Company in repurchased shares of stock held by the Company but not retired from circulation. These shares can be resold by the Company at a later date. The purchase of Treasury Stock by a Company is often used as a way of providing distributions to Shareholders as a Capital Gain versus as a Dividend which is taxed at regular income rates versus capital gain rates.
  3. Retained Earnings: This is the cumulative amount of earnings and/or losses from prior years that has been recorded.
  4. Current Year Earnings: This is the amount of current year earnings that are being recorded but have not yet been moved to Retained Earnings because the Company has not yet finished closing the books for the year. Once the books are closed for the year the Current Year Earnings or Losses will be added to the Retained Earnings amount.

On the Balance Sheet Net Worth is the same as Equity and indicates how much a business is worth in an accounting sense. The value of a business from a Balance Sheet perspective is not necessarily the same as the value of the business from a fair market perspective. The value of the business on the open market is a complex calculation involving many variables, including Balance Sheet Net Worth, but also including many intangibles and may include the expected future earning potential of the business.

If you have any questions or would like to have a conversation about your business goals please feel free to give me a call. I routinely consult with small business owners on how to improve their profitability and revenue and would be glad to have a conversation at your convenience.

Lee Thurburn – 214-772-6854