I often have business owners asking what is equity and how does it effect them. Let me bring some clarity to this elusive and yet important subject. Equity is the business owner's or partner's investments and draws in the business. A business owner adds equity to his business multiple ways. If it is a start up, often the owner has some moneys of his own that he invests into the business. As the business gets up and running often a business owner will leave  a lot of the profit in the business to help the business have capital to keep growing and operating.  The amount of equity rises and falls over time.  The net income (profit) at the end of the year increases the equity. Any draws that the owner or partner takes decreases the equity.

Lets look at a hypothetical scenario to illustrate how this works.  Joe has a sole proprietor business. The business net income at the end of the year is $200,000.  There is $150,000 in retained earnings (equity from previous years). Joe withdrew $100,000 as owners draw for the year. This gives him a remaining equity in the business of $250,000. This rolls over to the next year as retained earnings. The following year was a rough year and the business only had a profit of $50,000. However Joe withdrew $100,000 as owners draw just as he did the year before. This results in the retained earnings becoming $200,000.  And this my friends is a simple illustration of how equity ebbs and flows. For tax purposes one never wants to withdraw more moneys from the business as owners draw than equity that is in the business. By doing so capital gains tax is incurred.



If you would like to have Cowgirl Jo analyze your bookkeeping and help your numbers to become simply and sexy, schedule a free consultation below