What’s the Difference Between Owner’s Equity and Retained Earnings?
Owner’s equity refers to the assets minus the liabilities of the company. All owners share this equity. Owner’s equity belongs entirely to the business owner in a simple business like a sole proprietorship because this form of business has just a single owner. It belongs to owners of partnerships and LLCs as agreed to by the owners. Three categories on a balance sheet represent the business’s financial position from an accounting standpoint: assets, liabilities, and owner’s equity. Under each category are different accounts, like “cash” for assets, “supplies” for assets, and liabilities for things like taxes, a mortgage, or other debts. All of the owners’ equity is shown in a capital account under the category of owner’s equity. Retained earnings are corporate income or profit that is not paid out as dividends. That is, it’s money that’s retained or kept in the company’s accounts. An easy way to understand retained earnings is that it’s the same concept as owner’s equity except it applies to a corporation rather than a sole proprietorship or other business types. Net earnings are cumulative income or loss since the business started that hasn’t been distributed to the shareholders in the form of dividends. The statement of retained earnings shows whether the company had more net income than the dividends it declared.
Which Is Right for You?
All business types (sole proprietorships, partnerships, and corporations) use owner’s equity, but only sole proprietorships name the balance sheet account “owner’s equity.” Partners use the term “partners’ equity.” Partner ownership works in a similar way to ownership of a sole proprietorship. The partners each contribute specific amounts to the business at the beginning or when they join. Each partner receives a share of the business profits or takes a business loss in proportion to that partner’s share as determined in their partnership agreement. Partners can take money out of the partnership from their distributive share account. Owners of limited liability companies (LLCs) also have capital accounts and owner’s equity. The owners take money out of the business as a draw from their capital accounts. Corporations will use retained earnings.
How To Calculate Owner’s Equity or Retained Earnings
The basic accounting equation for this data point is “Assets = Liabilities + Owner’s Equity.” In other words, the value of a business’s assets is equal to what the business owes to others (liabilities) plus what the owners own (owner’s equity). Owner’s equity can increase or decrease in four ways.
Example of Calculating Owner’s Equity
Let’s say that a business opens its doors with $1,000 in assets, including cash, supplies, and some equipment. The business owner put in $200 of her own money, and she borrowed the other $800 from her local bank. So the initial accounting equation would look like this: (Assets) $1,000 = (Liabilities) $800 + (Owner’s Equity) $200 It could also look like this: (Owner’s equity) $200 = (Assets) $1,000 – (Liabilities) $800 Now let’s say that at the end of the first year, the business shows a profit of $500. This increases the owner’s equity and the cash available to the business by that amount. The profit is calculated on the business’s income statement, which lists revenue or income and expenses. Now the equation is: (Owner’s Equity) $700 = (Assets) $1,500 – (Liabilities) $800 But what if the owner took out $300 from the business as a draw during the year? The draw reduces the owner’s capital account and owner’s equity, so now the equation is: (Owner’s Equity) $400 = (Assets) $1,200 – (Liabilities) $800
The Bottom Line
Owner’s equity and retained earnings are largely synonymous in many circumstances, but there are key differences in exactly how they’re calculated. Many small businesses with just a few owners will prefer to use owner’s equity. Retained earnings are more useful for analyzing the financial strength of a corporation.
