Owner's Equity Definition and Examples (Plus How to Improve)
Updated February 3, 2023
Owner's equity is a financial term that anyone with assets may benefit from understanding. It can help you determine what you actually own and what your net value might be so you can make more informed decisions. Understanding the basic definition can improve your fundamental financial skills.
In this article, we explain the definition of owner's equity, show you how to calculate it, provide examples and explain how to improve your equity.
What is the definition of owner's equity?
The definition of owner's equity is the owner's investment in an asset after they deduct any liabilities. It's the difference between the number of assets and the value of liabilities that allows the owner to know what they own after paying off debts. Owner's equity is also called net worth or net assets. Because liabilities take precedence over equity, failing to consider liabilities can give a false sense of what you really own.
Though finding out owner's equity can be useful in determining your financial standing, it's important to note it's not representative of the true value of your ownership. This is due to various factors, including the fact that you only report owner's equity at the time you calculated the equity and it requires recalculation over time to determine gains or losses in value.
Related: Your Guide to Careers in Finance
Calculating owner's equity
Determining your owner's equity can be a great way to determine your financial standing. If you're seeking financial assistance from a lender or investor, it may also be a requirement. It's important to recognize that your owner's equity won't reflect your asset's true market value. You can calculate owner's equity by deducting the liabilities from the value of an asset. You can use the following equation:
Owner's equity = Assets - Liabilities
For example, if you own a house for $500,000 but you owe $300,000 on a loan against that house, the house represents $200,000 of equity. If your assets increase, so does your equity.
What to include in owner's equity
Here are the two factors to include when you determine your owner's equity:
Asset: An asset refers to something you own. This can be anything from a house, car, boat, furniture, business or your belongings.
Liability: A liability is the financial debt accrued against your asset. For example, a loan you take out against your assets, such as a home or car loan, is a liability.
If you own a corporation, owner's equity also consists of invested capital and retained earnings, defined as follows:
Invested capital: This refers to the funds invested by shareholders and debt holders in a business.
Retained earnings: Retained earnings is the amount of profit a company makes at a certain point in time after subtracting any dividends.
Combining invested capital with beginning and current retained earnings results in total owner's equity.
Owner's equity examples
Here are some examples that can help you better understand owner's equity in action:
Example 1: If you own a car worth $20,000 but you owe $5,000 against it, your owner's equity is $15,000.
Example 2: If you buy a house for $500,000 and pay $100,000 toward the loan, and have belongings worth $65,000, your liabilities are around $400,000. Your owner's equity is $165,000.
Example 3: If your business' assets amount to $4 million and the liabilities are $3 million, the owner's equity for the company is $1 million.
Related: How To Negotiate Equity in 9 Steps
How to improve your owner's equity
Here's how you can take steps to improve your owner's equity:
1. Lower your liabilities
To avoid depreciating your asset value, consider lowering your liabilities. For example, you can refinance any loans you have with loans that have a lower interest rate. This can help lower your liabilities while also reducing the overall cost to borrow money. You can also sell liabilities you don't necessarily need to reduce debts and increase liquidity.
2. Make upgrades and renovations
If you own a home and are hoping to improve your owner's equity, consider renovating your property. While you can't change your neighborhood, you can upgrade the property itself to increase its value. Some examples include a new paint job or purchasing new appliances. While purchasing new appliances might add to your debt, it can make the home more appealing to a future buyer. Consider improving or renovating crucial systems, like heating and cooling, drainage and basement waterproofing.
3. Maintain your property
Taking care of your assets is important whether you're trying to lower your liabilities or improve owner's equity. You can maintain your property but doing routine inspections on the interior and exterior of the building, following all laws and doing routine landscaping. Maintain both the aesthetic value of the property and the functionality of all its systems. For example, if you have leaky gutters, consider replacing them to protect your basement from unwanted moisture.
Related: What Is a Good Debt-to-Equity Ratio?
4. Pay off your debts
Paying off any accumulated debt can help lower any liabilities. You can do so by paying more than the minimum balance on any loans. For example, if you own a home, increase your mortgage payments and work on lowering your debt rather than accumulating it. Or, consider adding more to a monthly vehicle payment to pay off the loan for a depreciating asset like a car. Reducing debt can also help businesses by increasing profit margins and minimizing risks.
5. Reduce manufacturing costs
If you own a business, consider reducing manufacturing costs. This can mean using more economical products and machinery, streamlining operations, reducing the carrying cost of inventory or simply tracking your spending habits in relation to your business. You can also direct more financial resources into research and development to see how you can maintain the same level of quality and utility for your products while lowering their production costs.
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