Owner's equity is one of the simplest and most useful accounting concepts. It would be a mistake for some to think that owner's equity is the amount of money that could be earned on the sale of your business. This concept actually allows you to know how big your share of ownership in a business is from an accounting point of view. You must understand your business as to the value of assets, liabilities and share of ownership in order to calculate individual owner's equity.
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Part 1 of 2: Calculating Net Asset Value
Step 1. Calculate the total value of your business assets, including tangible goods owned by the business
Examples such as office furniture, equipment, supplies, and property are tangible assets. In addition, natural resource reserves and accounts receivable are recorded in the assets account.
Don't worry about calculating intangible assets such as copyrights and trademarks, favorable locations, public awareness, long-term contracts and workforce. Exceptions for which are capital investments (which are not expensed), will not appear in the accounting records as assets
Step 2. Calculate the contra account value of the business assets
This includes such as depletion, bad debt expense, and depreciation on assets owned by the company.
- For example, if equipment owned by a company had a certain value when it was purchased in 2010, say $100,000, and would depreciate in value in 2015. Then you need to find out how much that value has decreased over time.
- This will have nothing to do with market value. For example, if the machine is sold, it will not necessarily be sold at a depreciated value or not.
Step 3. Calculate the net asset value
This value will be obtained from subtracting the total assets of your business with the amount of the counter account.
For example, suppose you have total assets of $300,000, with a counter account amount of $100,000. Thus, you will subtract $100,000 from $300,000, resulting in $200,000 as the value of net assets
Part 2 of 2: Calculating Liabilities and Equity
Step 1. Calculate the total value of your business liabilities
Liabilities are financial obligations owned by the company. We recommend that you make timely updates in the trial balance. Be sure to include any accrued interest rates or fees, but not unbilled or unpaid fees (as these will be recorded as an expense). Examples of liabilities include salaries payable, taxes payable, interest payable, customer deposits, or accounts payable accounts.
- You must also include all contra accounts in question in the calculation of liabilities if any, bad credit for example. However, this rarely happens.
- The trial balance presents values at a certain point in time, so the values of assets and liabilities must be adjusted to the date indicated on the trial balance.
Step 2. Subtract the value of net assets with liabilities to obtain total equity
The breakdown, subtract the total value of assets by the total value of your business liabilities. If there is any remaining value, then this value is the equity of a business or owner's equity.
- Suppose using the previous example, you have $200,000 as net asset value with a loan of $50,000. Thus, the business equity is $200,000 less $50,000, or $150,000.
- Note that not all debts can be transferred because some are part of the owner's obligations and some are not. A company can have debt in its own name without liability from the owners.
Step 3. Calculate the equity of the individual owners
The share of equity is based on the percentage owned by each owner. The resulting figures will reflect the proportion of each holding in the equity of the business.
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If there are two equal ownership interests in the business, then each owner will own half of the total equity of the business.
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If there are two holdings but one owns 60% and the other 40% of the business, then the first owner represents 60% of the business equity and the second owner represents the remaining 40%. Using the previous example, the first owner will own 60% of the $150,000 which is $90,000, and the second owner 40% of the $150,000 which is $60,000.
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Tips
- Specific agreements regarding the division of business equity between owners may vary depending on the business, and these agreements will be discussed until mutual agreement is reached at the initial investment stage.
- Equity is not a unit price of a company, but the concept of value from an accounting perspective. For example, public companies usually sell at multiples of book value, whereas market value is not a concept of value in accounting.
- Owner's equity is not necessarily the basis for selling your business. The determination of the selling price must also take into account factors such as goodwill or the excess value of the business over owner's equity. Such factors are usually recorded as intangible assets such as the popularity of the brand and the favorable location of the business.
