Share Equity Vs Retained Earnings
Equity is one of the main components of the company’s balance sheet.
For a small company, equity represents the amount of owner investment into the business. These are the amount that belongs to the owner.
When the company starts the operation, they require the assets such as cash, inventory, and fixed assets. There are two types of funds that a company can use to purchase these assets. First, they can borrow money from a bank or creditor. It will increase the liability section on the balance sheet. Second, the company can get cash from the owners’ investment and it will increase the equity section on the balance sheet.
The balance sheet includes assets, liability, and equity. Assets equal to liability plus equity.
As mentioned, the assets are equal to liability plus equity. It means all the company assets will be funded by liability or equity. There are no other ways that the company can use to acquire these assets.
Besides the capital invested by the owner, the company equity can be increased through retained earnings. Retained earnings are the accumulated profit of the company from the start of the company up to the reporting date.
What is company equity?
Equity is the owner’s capital that has been invested in the company. It helps to support the company’s operation by paying for the salary, rental, cost of goods sold, and other operating expenses.
Besides the expense, it can also use to purchase the current assets and fixed assets. Even if the company has not yet purchased anything, the cash balance is also part of the assets that the owner has invested.
The company needs equity to start the operation. In the beginning, the company equity refers to the owner capital only. It is almost unlikely to start the company base on 100% of liabilities.
For listed companies, the equity has many components such as capital, additional paid-in capital, common stock, preferred stock, and so on.
Common stock is the amount of par value of common stock that company issues to the capital market. Additional paid-in capital is the extra amount that investors paid more than the par value.
What is the company retained earnings?
Retained earnings are the accumulated profit from the beginning of the business up to the reporting date.
When we start the company, the retained earnings will be zero. All of the invested cash will be recorded as capital.
After the end of the first accounting period, the profit or loss will impact the retained earning balance. The profit will increase the retained earnings balance. However, the net loss will reduce the retained earnings balance.
If the company generates a loss, it will keep reducing the retained earnings to zero balance. After it reaches zero, the balance will become negative if the company keeps making a loss. The negative retained earnings will reduce the total equity balance of the company.