Everything You Need To Know About Equity Accounts

As a business owner, you may wonder what an equity account is and how it can help your business. Equity accounts can help you understand how much money your business is worth and track any changes in the share price.

Equity accounts can also be used to report financial information to shareholders.

In this article, you will understand what an equity account is and the types of equity accounts you can use as a business owner.

What Is An Equity Account?

Equity accounts is the amount of money the owner invested in the business. It is also any profits or losses that the company earned or incurred since the owner’s contributions.

Equity is a key part of the accounting equation: Assets – Liabilities = Equity. It is found on the bottom half of a company’s balance sheet and represents the owner’s stake in the company.

Additionally, the equity account can include dividends or distributions paid to the owners. If the company has profits but doesn’t distribute dividends, it is then considered as retained earnings. 

Let’s break it down further below.

How Does Equity Accounts Work?

One of the most important aspects of accounting is understanding the different types of accounts and how they work. Equity accounts are a key part of this, and it’s important to understand how they work in order to make sound financial decisions.

Let’s start by breaking down the accounting equation: Assets – liabilities = Owner’s equity.

Assets are everything a company owns and can use to generate income. This includes items such as cash, investments, and property. Liabilities are what a company owes to others. This includes things like loans, accounts payable, and taxes.

Equity is the difference between total assets and total liabilities. It represents the portion of the company that belongs to the owners.

The equity balance reflects the company’s net worth and changes in value over time. 

It can be divided into two categories: contributed equity and retained earnings. 

Contributed equity is what the owners have put into the company. This includes items like cash or stocks. 

Retained earnings are money that the company/owners reinvest into the company.

Although there are two categories, we also recognize equity accounts that decrease the owner’s share. These are called contra equity accounts. An example of a contra equity account is distributed equity. Distributed equity is the amount of money an owner takes out of the company. 

Types of Equity Accounts:

There are four main types of equity accounts: common stock, preferred stock, paid-in capital, and retained earnings. The name of the equity account is determined by the business structure. 

For example, a sole proprietorship would have a “capital account” while a corporation would have “common stock,” “preferred stock,” and “additional paid-in capital.”

The most common type of equity account is “common stock.” This account represents the ownership interest in the company. The holder of common stock is entitled to vote on corporate matters and share in the profits (or losses) of the company.

Partnerships, Sole Proprietors, LLCs, and S Corporation Owners

Equity accounts under LLCs, Partnerships, and S Corporations can all be treated the same as they are pass-through entities. An owner will either invest in their business or withdraw funds.

Examples of Sole Proprietor and LLC equity accounts:

There are two ways you can group equity accounts with partnerships, LLCs, and S corporations; money coming in and money going out of the company.

Below are examples of equity accounts that represents the amount of money coming into the business under a Sole Proprietor or LLC:

• Owner’s Contributions 
• Owner’s Capital
• Owner’s Equity

The following are examples of equity accounts that specify money going out of the business as an LLC or Sole Proprietor:

• Owner’s Draw
• Owner’s Distributions

Partnerships and S Corporations

Partnerships and S corporations with two or more owners usually name their equity accounts differently than entities with one owner.

Below are Examples of Partnerships and S Corporation equity accounts; Money in accounts.

• Partner’s Capital
• Partner’s Contribution

Below is an Example of Partnerships and S Corporation equity accounts; Money Out Accounts

• Partner’s Distributions

Corporations

There are three types of equity accounts under corporations: common stock, preferred stock, and retained earnings. 

Common stock is the first type of equity account, and it represents the ownership interest in a corporation. The holder of common stock has the right to vote on corporate matters and to receive dividends if they are declared.

Preferred stock is the second type of equity account, and it represents a claim on corporate assets ahead of common shareholders. 

Preferred shareholders typically do not have the right to vote on corporate matters, but they do have the right to receive preferential treatment with respect to dividends. 

Retained earnings are the third type of equity account, and it represents the cumulative profits (or losses) of a corporation that have not been distributed to shareholders.

Common Stock

When a company wants to raise money from the public, it can do so by selling common stocks. This is different from selling bonds, which is when a company borrows money from investors.

When a company sells common stocks, it is giving up a piece of ownership equity in the company to its new shareholders. This is also known as Shareholder’s equity. 

In exchange for this ownership stake, the shareholder becomes entitled to a portion of the company’s profits and assets.

Common stocks are attractive to companies because they offer a way to quickly raise large amounts of money. In addition, common stockholders have no guaranteed return on their investment, meaning they can make a lot of money if the company does well or lose everything if it fails.

For this reason, common stocks are considered to be high-risk investments.

Preferred stock

Preferred stock offers some of the features of common stock but also has features that make it different. For example, preferred shareholders usually get a fixed dividend payment each year, regardless of how well the company is doing.

Preferred stock is more like a loan to the company than an ownership stake. It usually comes with certain benefits, such as guaranteed dividends and the right to be paid back before common shareholders if the company goes bankrupt. 

Most businesses issue or buy preferred stock because it offers a higher return on investment than common stock.

For example, if you buy $1,000 worth of preferred stock in Company A, you might receive a regular dividend payment of $10 per year. If Company A goes bankrupt, the holders of its preferred stock will be paid back before holders of its common stock.

Retained Earnings

A corporation’s retained earnings account is a record of the cumulative profits or losses that the company has earned since it was first formed. The retained earnings account is increased by profits and decreased by losses, and the balance in this account represents the net worth of the company.

The retained earnings account is important because it provides a measure of the financial health of the company. A high balance in this account indicates that the company is profitable and has a strong financial position.

A low balance, on the other hand, suggests that the company may be in financial trouble.

The retained earnings account can also be used to measure how successful a company has been over time. A high balance in this account indicates that the company has been profitable and growing, while a low balance suggests that the company may be struggling.

Some other terms used to describe equity.

When a company has more cash on hand than what is needed to run the day-to-day business, the excess is often invested in long-term assets such as real estate or securities. 

The cash used to purchase these investments is called paid-in capital. This term can also be used to describe the total amount of money that a company has raised from investors. 

In addition to paid-in capital, a company may also have additional paid-in capital. This refers to any amounts not included in the original investment round and includes profits earned from selling shares above the initial price. 

Finally, companies may issue treasury stock when they sell shares they have already purchased back from investors.

Is an equity account an asset or liability?

There is much debate over whether an equity account is an asset or liability. The answer to this question depends on how you define each term. Generally, an asset is something that gives a company value, and a liability is something that takes away from a company’s value.

An equity account is essentially a record of the owner’s investment in the company. It represents the portion of the business that belongs to the owner and can be used to calculate the owner’s percentage of ownership in the company.

An equity account can be considered an asset because it gives the company value. The owner has a stake in the business and can receive dividends or other distributions from profits.

However, some argue that an equity account should be classified as a liability because it obligates the owner to contribute more money if needed. The company could also sell off its assets to repay the owner’s investment.

Conclusion

Equity accounts are found on the balance sheet and represent the shareholder’s equity in a company. The account includes information about the company’s profits and losses, distributions to shareholders, and contributions from shareholders.

The account shows the change in the company’s equity over time and is the difference between the company’s assets and liabilities.