What Causes a Decrease in Owner's Equity?
Owning equity in a company means that you own all or part of it. The owner’s equity account is listed on the balance sheet for accounting purposes. There are a few reasons for a decrease in owner’s equity.
Equity refers to the ownership either individuals or entities have in a company. In financial terms, a company is translated into assets, liabilities and equity. Assets are items such as cash, equipment and intellectual property that represent value. Liabilities are items such as debt payments that represent what a business owns. Owner's equity represents investments made by owners. On the balance sheet, the assets of a company equal its liabilities plus equity. Therefore, equity equals assets minus liabilities.
You can generate equity in two different ways: through paid-in capital or retained earnings. When owners start a company, they often pay for part of it with their own money. In return for the money they invest, the owners receive shares proportionate to their investments. However, owners’ investments in companies are not limited to their original investment amounts. Owners can increase the amount of money they want to invest when the company is up and running, thereby garnering additional shares for their increased investment. Moreover, new investors can also invest money by buying newly issued company shares. Paid-in capital refers to all these instances where owners invest money in a company and get shares in return.
A company’s profits end up either as dividends or retained earnings. Shareholders receive money according to the percentage or proportion of the company they own. The money they receive comes from the company’s profit. These payments are called dividends. Typically, companies pay out only a portion of their profits in dividends. They also retain a portion and add this amount to the company’s equity. This amount is the retained earnings.
Decrease in Equity
A decrease in the owner’s equity can occur when a company loses money during the normal course of business and owners need to move equity into normal business operations. It also decreases when an owner withdraws money for personal use. A company might also suffer a decrease in equity because of some unusual event that requires owners to invest equity in replacing assets, such as when a natural disaster destroys equipment or inventory.