BASIC FINANCE

Statement of Owners Equity and Statement of Cash Flows

What is Owner's Equity?

Owners equity is the dessert of the accounting field. This is the one topic everybody likes to discuss, and that most individuals who own and operate a business really like to watch as it increases. What is the correct definition of owners equity, and why is it one of the most important pieces of the accounting reporting? Owners equity is the owners rights to the assets of the business. If the business is a sole proprietorship, the owners equity is also known as the owners capital account. As this figure increases, the owners right to the assets of the business increase. More simply translated, the larger the equity, generally, the smaller the debt. What can an owner do with the figures represented in the Owners equity area? The options are many. If a small business owner wants to expand the business, the greater the amount of equity, the more likely a lending institution will be to grant additional funds for the expansion. If an owner wants to sell the business, the owners equity is the basis for the asking price of the business. It is not the only contributing factor in determining the value of the business, but it is the baseline figure providing a definite foothold for establishing the value of the business. How does this figure grow in value? What is the catalyst for the increase in owners equity? The retained earnings shown on the income statement are the greatest contributor to an increase in owner equity. The greater your profitability in your business, and the more of the income you retain, the greater your owner equity will become. This figure also increases as debt is paid down or completely off. This is a great example of the links between the income statement, statement of cash flows, and the balance sheet. When you follow the trail of information through each report, you can begin to understand the importance of this trio. What happens when money is withdrawn from owners equity? If a business owner chooses to withdraw funds from the owners equity account, the value of the funds withdrawn will be taxed as capital gains. Right now, capital gains tax is at an all-time low. If you were going to make an exit from your business, or make a lump sum withdrawal, now is the perfect time to consider such a move. The owners equity column is also the difference on the balance sheet between asset and liability accounts. The accounting equation used to represent this is: Assets - Liabilities = Owners Equity

BASIC FINANCE

Statement of Owners Equity and Statement of Cash Flows

Statement of Owner's Equity Definition

A statement of owner's equity is one of the four main financial statements that quantify the financial position of an organization's activities at a particular point in time. Although it may also be commonly known as a statement of shareholder's equity, the purpose is identical. The statement of owner's equity details the changes to the owner's equity account during the accounting period as the organization issues dividend payments and retains money for use within the organization for investment. To fully define the statement of owner's equity, you have to reconcile the previous equity balance with withdrawals (or dividend payments), investments and income of the current accounting period. The Statement of Owner's Equity shows the change in owner's equity during a given time period. It lists the owner equity balance at the beginning of the period, additions and subtractions to the balance, and the ending balance. Additions come from owner investments and income; subtractions from owner withdrawals and losses.

Function
The purpose of the statement of owner's equity is to show the reasons for any changes to the owner's equity, or "capital," that occurred within the reporting period. Owner's equity represents the book value of a company, and is composed of the owner's contribution to a company and the net income retained within the company. Book value is also referred to as "net assets": assets less liabilities. Healthy companies have positive book values, whereas companies with negative book values are bankrupt. By comparing a company's statement of owner's equity from different periods, you can discover trends that may affect the solvency of a company.

BASIC FINANCE

Statement of Owners Equity and Statement of Cash Flows

Components
The Statement of Owner's Equity is composed of the following information: 1. 2. 3. 4. 5. 6. Identification of the owner, the statement and the reporting period. The amount of owner's capital at the beginning of the period. Investments into the company during the reporting period. Net income for the period. This figure is taken from the period's Income Statement. The amount of owner's capital withdrawn during the reporting period. The ending amount of owner's capital. This figure is used on the period's Balance Sheet.

How to make a Statement of Owners Equity?

Step 1. Refer to the previous statement of owner's equity to determine the ending balance for the last accounting period. This figure serves as your beginning balance for the current accounting period. You need the beginning balance to calculate the change in the owner's equity account for the current accounting period. This is the first piece of data you need to balance the equity equation. Step 2. Calculate net income by subtracting the amount of money you spent on expenses to generate revenue from your organization's operations. The basic net income equation is as follows: Net Income = Revenue - Expenses A more specific net income equation accounts for capital gains and losses. Capital gains may be an increase in value of your investment. Conversely, a capital loss is a loss of value on your investment. This is another piece of data you need to generate the statement of owner's equity. Step 3. Determine how much money was retained by the organization for investment. Capital investments such as machinery, equipment and the like are all considered assets for the organization if such investment will be used to generate income. Step 4. Calculate how much money was withdrawn from the owner's equity account. In general, the owner's equity account is an owner's claim on profits. Higher balances in owner's equity accounts may correlate to low debt levels and may be a sign of the good financial health of an organization. Withdrawals from the owner's equity account for personal use or as dividend payments may affect the ending equity balance that appears on the statement of owner's equity at the end of the accounting period.

BASIC FINANCE

Statement of Owners Equity and Statement of Cash Flows

Step 5. Calculate the ending balance for the statement of owner's equity. Calculate the difference between investment and withdrawals from the owner's equity account. Take this figure and add it to income and the beginning equity balance. See the formula below: Ending Equity Balance = Beginning Equity Balance + Investments - Withdrawals + Income The total from this formula is the ending equity amount reported on the statement of owner's equity.

How to use the Statement of Owners Equity?

A statement of owner's equity is a very common financial statement used by most companies. This statement shows all owners of a business the amount of equity they began the period with, any changes to their equity and their ending equity balances. The ending equity amounts are used in completing the balance sheet, which is another common financial statement all businesses use. Equity simply represents an owner's rights to the assets a business owns. Step 1. Place the beginning owner's equity amount on the top of a financial statement. If there is more than one owner, list each owner in a separate column at the top of the financial statement and each owner's beginning equity amount. Step 2. Add in any contributions made by owners. Place each amount in individually based on what was contributed and the dollar value. Contributions can be either monetary or a donation of an asset. Net profits from the company are added in at this point as well. All net profits increase the owner's equity in the business. Add all contributions to the beginning equity amount. This amount is placed on the next line. Step 3. Deduct any withdrawals made by owners. Each owner's withdrawals should be listed individually and can be monetary or a withdrawal of an asset. If the company suffered a net loss, this amount is deducted from the owner's equity at this point. Net losses result in the reduction of the owner's equity. Deduct all withdrawals from the owner's equity amounts. The resulting figure is the owner's ending equity amounts for the end of the period. Step 4. Analyze the statement to see exactly where equity amounts derived from. Business owners and investors can tell if the company's equity increased based on owners' contributions or on profits made by the company.

BASIC FINANCE

Statement of Owners Equity and Statement of Cash Flows

Examples of Statement of Owners Equity

BASIC FINANCE

Statement of Owners Equity and Statement of Cash Flows

What Is A Cash Flow Statement?

Complementing the balance sheet and income statement, the cash flow statement (CFS), a mandatory part of a company's financial reports since 1987, records the amounts of cash and cash equivalents entering and leaving a company. The CFS allows investors to understand how a company's operations are running, where its money is coming from, and how it is being spent. Here you will learn how the CFS is structured and how to use it as part of your analysis of a company.

Structure
The cash flow statement is distinct from the income statement and balance sheet because it does not include the amount of future incoming and outgoing cash that has been recorded on credit. Therefore, cash is not the same as net income, which, on the income statement and balance sheet, includes cash sales and sales made on credit. Cash flow is determined by looking at three components by which cash enters and leaves a company: core operations, investing and financing.

Usage
1. The cash from operating activities is compared to the company's net income. If the cash from operating activities is consistently greater than the net income, the company's net income or earnings are said to be of a "high quality". If the cash from operating activities is less than net income, a red flag is raised as to why the reported net income is not turning into cash. 2. Some investors believe that "cash is king". The cash flow statement identifies the cash that is flowing in and out of the company. If a company is consistently generating more cash than it is using, the company will be able to increase its dividend, buy back some of its stock, reduce debt, or acquire another company. All of these are perceived to be good for stockholder value. 3. Some financial models are based upon cash flow.

BASIC FINANCE

Statement of Owners Equity and Statement of Cash Flows

Operating Activities
Operating activities are normal daily operating activities of running a business. The indirect method of preparing the Statement of Cash Flows adjusts the net income figure to remove noncash revenues and expenses. Also removed are items like gains and losses that are not attributable to the operating activities of the business. In considering changes in current assets and liabilities, it should be remembered that changes in notes receivable and notes payable are not shown as operating section adjustments. Changes in notes receivable is shown in the investing section, while changes in notes payable is shown in the financing section. The general reconciliation format for the operating section is as follows: Net Income + Depreciation expense + Losses - Gains - Increases in current assets + Decreases in current assets + Increases in current liabilities - Decreases in current liabilities ----------------------------------= Cash flows from operating activities ========================

1. Depreciation is a non-cash expense that reduces net income. Therefore, it is added back to
put net income on a cash basis. 2. The total cash proceeds from the sale of assets is reported in the investing section of the statement. The effect of gains and losses is removed from net income. Gains are subtractions because they increased net income. Losses are additions because they decreased net income. 3. Consider accounts receivable in regard to current assets. An increase in accounts receivable increases net income because of the associated revenue. However, since no cash is provided, the increase in this current asset is shown as a reduction to put net income on cash basis. The

BASIC FINANCE

Statement of Owners Equity and Statement of Cash Flows

reverse is true for a decrease in accounts receivable. A collection of accounts receivable provides cash but does not affect net income. Therefore, the decrease in this current asset is an addition to put net income on a cash basis.

4. Consider accounts payable in regard to current liabilities. An increase in accounts payable decreases net income because of the associated expense. However, since no cash is yet paid, the increase in this current liability is shown as an addition to put net income on a cash basis. The reverse is true for a decrease in accounts payable. A payment of accounts payable uses cash but does not affect net income. Therefore, the decrease in this current liability is a subtraction to put net income on a cash basis.

Investing Activities
Buying and selling property, plant, and equipment items are classified as investing activities. Also, all investments, (current and long-term) are classified as investing activities whether buying or selling the investment. Usually cash changes from investing are a "cash out" item, because cash is used to buy new equipment, buildings or short-term assets such as marketable securities. However, when a company divests of an asset, the transaction is considered "cash in" for calculating cash from investing.

Financing Activities
Financing activities include transactions affecting long-term liabilities and stockholders' equity accounts, including the payment of cash dividends. Short-term borrowing and repaying of loans is also a financing activity. However, note that payment of interest expense is considered part of operating activities. Since net income is already reduced for interest expense, the only adjustment that might be required in the operating section is for changes in interest payable. Changes in debt, loans or dividends are accounted for in cash from financing. Changes in cash from financing are "cash in" when capital is raised, and they're "cash out" when dividends are paid. Thus, if a company issues a bond to the public, the company receives cash financing; however, when interest is paid to bondholders, the company is reducing its cash.

BASIC FINANCE

Statement of Owners Equity and Statement of Cash Flows

Tying the Cash Flow Statement with the Balance Sheet and Income Statement
As we have already discussed, the cash flow statement is derived from the income statement and the balance sheet. Net earnings from the income statement are the figure from which the information on the CFS is deduced. As for the balance sheet, the net cash flow in the CFS from one year to the next should equal the increase or decrease of cash between the two consecutive balance sheets that apply to the period that the cash flow statement covers.

Conclusion
A company can use a cash flow statement to predict future cash flow, which helps with matters in budgeting. For investors, the cash flow reflects a company's financial health: basically, the more cash available for business operations, the better. However, this is not a hard and fast rule. Sometimes a negative cash flow results from a company's growth strategy in the form of expanding its operations. By adjusting earnings, revenues, assets and liabilities, the investor can get a very clear picture of what some people consider the most important aspect of a company: how much cash it generates and, particularly, how much of that cash stems from core operations.

BASIC FINANCE

Statement of Owners Equity and Statement of Cash Flows

Example of Statement of Cash Flows

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