All about Equity
Equity represents how much of your company is really yours and not owed to someone else. Think of it in terms of your house: You own your house, but the bank probably has a claim on part of it, too, in the form of your mortgage. Here your house is your asset, your mortgage is your liability, and the part of your house that you truly own (the difference between its value and your outstanding mortgage balance) is your equity. It's exactly the same for business. You have your assets, you owe your liabilities, and you own your equity stake.
Equity does have a slightly tricky angle; its makeup depends on what type of business structure you choose for your company. As you will learn in Chapter 15, the different business structures include sole proprietorships, partnerships, limited liability companies, and corporations. The structure of your company dictates how the equity looks for accounting purposes and exactly what types of equity accounts will appear in your books.
The main split among equity accounts, common to all business types, is in which direction the capital is flowing. There are equity contributions, which means owners put more of their own cash into the company. There are equity withdrawals, which means owners take money out of the company, but not as regular salary. Finally, there is the temporary profit or loss that becomes a permanent piece of the equity account. As you might expect, profits increase your equity, while losses decrease it.
It's possible, and not uncommon, for new businesses to end up with negative equity after their first year or two in business. This happens when early losses are greater than your initial capital investment. Having negative equity shows that your business is struggling, but you still may be able to turn things around if you have some cash and a workable idea for boosting revenues.