Owners Equity is part of the Basic Accounting Equation,
ASSETS = OWNERS EQUITY + LIABILITIES
When looking at this basic accounting equation, we can see that Assets are financed with either Debt or Equity, meaning that in order to purchase assets, one needs to either borrow funds to purchase the asset or use internal funds of the business to purchase the assets.
Understanding what the Owners are entitled to is critical is valuing the Net Worth of the business because we can rearrange the equation and make Owners Equity the subject of the equation.
OWNERS EQUITY = ASSETS - LIABILITES
When considering this equation, we can state that the owners would be entitled to the residual which is remaining after the business pays back all of its liabilities with its assets. Should the business end up with more Assets than Liabilities then this will result in a positive Owners Equity amount (meaning their is additional value for the owners of the business). Should Liabilities exceed Assets then there will not be any value for the owners. If Liabilities are greater than Assets then the business would be considered bankrupt.
Here is the next video in the Accounting for Non-Accountants video series explain Owners Equity in more detail. It’s a really useful resource for helping you to better understand various basic accounting concepts if you don’t have a background in accounting.
A principle-based approach is best for learning and applying accounting.
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