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Understanding Your Balance Sheet - 3. Make Up - Equity

This is the 3 in a series of posts that have the aim of helping you, the business owner, to better understand your Balance Sheet so that you can use it to work for your business.

Make Up

We are currently looking at the different categories of accounts that make up the Balance Sheet. The last two posts explained the Assets category of accounts and then the Liabilities categories of accounts that can be found on the Balance Sheet. In this post we will be looking at the final category of accounts that can be found on a Balance Sheet – Equity.

Equity

The Equity category of accounts effectively make up the “other side” of the Balance Sheet:

                Assets – Liabilities = Equity

The Equity represents the money that has been invested in the business and can be shown across several different types of accounts:

  • Retained Earnings/Profit
  • Shares (Companies Only)
  • Owner Current Accounts

We will look at each of these in turn.

Retained Earnings/Profit

This account represents the net value of Profits less Losses from previous years’ worth of accounts after taxes and, for companies, dividends have been paid. Effectively the profit has been retained by the business in order to continue to help finance the business.

For businesses using a computerised accounting system, when the year-end accounts are ‘rolled’ over, all the “Profit and Loss” accounts are cleared of their balances, and the net balance of these accounts gets posted to the Retained Earnings/Profit account.

Shares (Companies Only)

Whatever the size of an incorporated company, whether it be a small sole owner company or a large multinational company listed on a stock exchange, there will be shares, the value of which will be represented by share accounts on the Balance Sheet. Share accounts on the balance sheet represent the value that an owner of a business, whether one owner or multiple owners, have invested in the business.

In general, unless a business is expanding, and alters its share structure in order to release more shares to obtain more investment income, then the book value of the shares shown on the Balance Sheet should remain the same. (Market value of publicly listed shares is of course another matter).

Owner Current Accounts

Owner current accounts are usually only seen on the Balance Sheets of smaller privately owned businesses. As with shares these accounts represent the monies that owners have put into a business. However, unlike shares, these accounts can fluctuate in value on a regular basis.

Owners may invest funds into the business in order for the business to pay costs etc., but then, when the business is making money and can pay its own costs the owners may choose to withdraw some of their funds.

As long as the current accounts remain in credit, i.e. more money has been put in then taken out, the drawings by an owner are seen as just that (withdrawing own money) and are not taxed. However, once an owner withdraws more money than they originally put in the drawings are then seen to be a salary and are taxed accordingly.


This then completes our look at the types of accounts that make up a Balance Sheet. In the next post we will look at Control Accounts on the Balance Sheet.

3 Comments to Understanding Your Balance Sheet - 3. Make Up - Equity:

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