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What Does Equity ACTUALLY Mean? - YouTube
Channel: Accounting Stuff
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in this video you'll find out what
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equity means that accounting I'm going
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to give you two definitions yest then
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we're going to break it down to see what
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it's made up and take all of the pieces
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and fit them back together to get a
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complete picture of what equity is and
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how it fits into the expanded accounting
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equation hey viewers I'm James and
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welcome to accounting stuff the channel
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that teaches you all you need to know
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about counting and bookkeeping if you'd
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like to learn more about these topics
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then check out my accounting basics
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playlist up here I think we're almost up
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to 20 videos now and I keep adding to it
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each week so subscribe and hit the bell
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to be notified when the next video is
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out over the past couple of weeks we've
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talked about assets and liabilities
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which leads us nicely into today's topic
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equity the third and final pillar of the
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accounting equation which looks like
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this assets are equal to liabilities
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plus equity I've had plenty of requests
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for this topic and I totally get why
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equities the oddball in the accounting
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equation and there are so many different
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terms and jargon that come with it as
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part of the parcel Wow so many and this
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isn't even all of them but I've cherry
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picked these ones to teach you today
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because if you can understand these then
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you'll have a solid grasp of what equity
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means and to be honest you'll be far
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ahead of most of the other people out
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there who is still battling with this
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topic oh and by the way if my voice
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sounds funny today it's because I've
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been struck down by the man flu we've
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had a chilly week in Vancouver and has
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finally got to me but anyways are you
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ready the let's do this at the start of
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this video I promised you two
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definitions of equity in accounting and
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here's the first equity is the residual
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value of an entity's assets after
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deducting all its liabilities that's it
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hold on I'll explain how this works
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first let's bring up the accounting
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equation again you'll be seeing this
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quite often in this video and it'll
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become clear why later on assets are
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equal to liabilities plus equity if we
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rearrange this formula then we can see
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that equity is made up of assets minus
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liabilities now we accountants have
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another word to describe assets minus
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liabilities
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net assets I said a moment ago that
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equity is the residual value of an
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entity's assets after deducting all its
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liabilities residual value basically
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means what's left over after you take
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all of an entity's assets and deduct its
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liabilities in other words what we've
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got here equity represents the net
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assets of a business simple hey yes it
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looks simple but what does it actually
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mean definition number two is gonna help
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us shed some light on this it says that
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equity represents the net funds invested
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into a business by its owners I like
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this description of a grotty because it
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gives us some context let me explain
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with the help of the accounting equation
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on the broadest scale there are two ways
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that funds can be invested into a
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business to finance its operations and
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you're currently looking at both of them
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it could choose to borrow money from
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third-party lenders like banks which in
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essence are liabilities or it could
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choose to use the net funds invested
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into the business by its owners in other
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words it could choose equity so now we
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know that equity represents the net
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assets of a business and at the same
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time it represents the net funds
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invested into the business by its owners
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so what we're saying here is that the
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owners of a business owned will have a
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claim on all of its net assets and we
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call this equity make sense now that
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we've got an idea of what equity means
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let's have a look and see what it's
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actually made of full disclosure here
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equity is made up of a lot of things and
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some parts are a bit complicated but I
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mentioned at the start that I've cherry
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pates the parts that I think are most
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important that will give you the most
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value 3 in particular that together will
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give you a solid understanding of what
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equity is and I'll share them with you
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in a moment but first I think will be
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easier for you to picture all of this if
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we work with an example imagine that
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you've got an idea for a business you've
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been following the plastic free bed
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movement on the internet and you've come
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across this video 90%
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you realize that plastic makes up 90% of
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all ocean debris so you come up with an
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idea to decrease the number of plastic
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bags by developing your own reusable
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shopping bag to help save the planet but
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there's a problem you have a choice to
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make that all startup businesses end up
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facing how to structure your business
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you could choose to go it alone become a
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sole proprietor and avoid incorporating
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the business as a separate legal entity
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you could go in 50/50 with a mate and
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form a partnership or you could decide
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to create your own corporation a
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separate legal entity that's owned by
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shareholders now there are pros and cons
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to each of these but that's for another
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day let me know down the comments if
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you'd like to hear more about it I want
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us to rewind for a second I said that
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equity is essentially made up of three
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things and the reason why I've laid all
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this out here is because the words we
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used to describe these three things
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changes depending on the structure of
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the entity and I think that's partly
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what makes equity seem so complicated
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there is so much different jargon that
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we used to describe what is essentially
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the same thing let me show you the first
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thing that makes up equity is capital
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contributions capital relates to the
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funds raised to support a business and
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contributions simply mean that these are
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given to the business so capital
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contributions is the money that the
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owners invest into the business out of
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their own pockets now the way that we
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describe this changes depending on who
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the owners are and that changes based on
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the structure of the business if you're
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a sole proprietor then there's only one
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owner you so you'd call the money that
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came out of your own pocket owner's
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equity however if you were part of a
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partnership then the owners of the
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business would be the partners so you'd
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call the capital contributions partner
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contributions and if you created a
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separate legal entity a corporation then
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the owners of the business would be the
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shareholders and you'd call the funds
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invested shareholders equity so we have
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three different terms that describe
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basically the same thing
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capsule contributions are one of the
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ways that businesses tend to fund
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themselves during the early start
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days before they become profitable
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imagine that you choose to become a sole
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proprietor at least at first and you
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invest $1,000 of your own money into
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your reusable bag business
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what's your business's financial
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position let's bring up the accounting
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equation again your business has assets
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of $1000 in the form of cash and you the
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owner have a claim of $1000 on those
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assets which we call owner's equity the
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accounting equation is in balance as it
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should be because when we're looking at
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a snapshot of a business's assets
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liabilities and equity at a single point
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in time we're looking at its balance
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sheet now capital contributions aren't
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the only thing making up equity when
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your business generates revenues or
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incurs expenses is to make a profit or a
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loss which is just revenues less
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expenses what happens to that profit and
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who does it belong to you of course
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you're the owner so you could choose to
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reinvest these profits back into the
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business or hold on to them to use in
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the future
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over time these profits and losses that
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you're holding on to build up and we
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call them retained earnings retained
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earnings are defined as accumulated
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profit held for future use and
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thankfully this term stays the same
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regardless of whether you're a sole
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proprietor a partnership or a
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corporation your business's equity is
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made up of two things capital
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contributions and retained earnings over
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time your reusable bag business starts
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to make some real money so much in fact
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that you no longer need to dip into your
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own pocket to fund it using capital
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contributions you can cover all of the
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expenses using the accumulated profits
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that you've held on to and set aside
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you've retained earnings within a year
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your business is booming you've got much
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more money coming in than what's going
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out in other words you've got a net cash
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inflow but back home all is not so rosy
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you've invested so much of your own
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savings into the business through
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capital contributions they are running
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out of money to live on for yourself you
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need to withdraw some cash out of the
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business to cover your own personal
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expenses well how does that work
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retained earnings are made up of a
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couple of things remember I said that
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they're your accumulated profits help a
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future use so a big chunk of your
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retained earnings is your accumulated
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profits which are your revenues less
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your expenses
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which comes straight from your income
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statement an income statement is a
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financial report that you use to track
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your revenues and expenses over a period
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of time but retained earnings are also
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made up of withdrawals the money that's
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taken out of the business and
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distributed to its owners we have
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different terms to describe withdrawals
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depending on the structure of your
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business for sole proprietors we call
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them drawings and for partnerships we
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call them partner drawings and for
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corporations we call them dividends
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which a profits distributor to the
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shareholders again we have three terms
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all used to describe what is essentially
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the same thing withdrawals as the sole
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proprietor your reusable bag business
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you can use drawings to withdraw your
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accumulated profits for personal use
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this impacts the accounting equation by
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decreasing assets because the business's
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cash has gone down and decreasing equity
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because your claim on those net assets
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has decreased hold on now I want to show
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you something interesting we've broken
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equity down into capital contributions
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retained earnings and withdrawals but
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let's see how this all fits together
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using the accounting equation earlier I
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said that when we look at a snapshot of
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the accounting equation at a single
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point in time we're looking at a balance
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sheet the balance sheet is made up of
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three things assets liabilities and
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equity and we know that equity is made
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up of capital contributions from the
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businesses owners and retained earnings
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which are its accumulated profits held
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for future use retained earnings break
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down further still into accumulated
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profits less withdrawals and accumulated
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profits are a business's revenues less
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expenses which when looked at over a
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period of time make up its income
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statement so what we've got here is the
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expanded accounting equation and I like
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this because we can see how two of the
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business's major financial statements
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the income statement and the balance
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sheet are linked together through equity
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thanks for watching if you found this
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video useful give it a like share it
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comment subscribe if you haven't already
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do you remember that guy from the video
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I showed you earlier well that's
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actually my brother will he created the
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campaign for plastic free Feb so if
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you'd like to learn more about that and
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how to get involved then join the
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Facebook group and follow their
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Instagram I'll drop the links to these
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down in the description below it's a
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great cause and it would be awesome to
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have you involved the next time and you
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don't even have to wait till February
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you can follow some of their
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recommendations and start cutting back
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on some of that plastic now as always
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let me know down in the comments if
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you've got any questions or message me
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directly on instagram at accounting
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staff see you next time
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