Owner equity is the business owner’s right to the assets of the business, after all liabilities have been paid.
Think of the business as a separate entity from the owner. At the start of the business, the owner invests money into his business in the form of capital. That capital is used to buy other assets – in a simple trading, buy-and-sale business, stocks/inventories are bought for resale at higher prices later on. Capital may need to go towards buying properties, such as a shoplot, or motor vehicles. As the business gets bigger, staff may need to be employed – and their wages will come from the capital invested.
Over time, the business should start to generate profits – when revenue (what is received as a result of selling goods or services) exceeds expenses (what is used up or spent in order to generate/create revenue). These profits will be added to owner’s equity – they represent the gains made on the owner’s original investment, or capital.
Of course, there is a possibility that a business will make losses too. This is when the revenue earned does not exceed expenses. This will drain the business’ capital, and it’s obvious that total losses cannot go beyond what the owner has invested in the form of capital; to continue operations, the owner would have to inject further capital.
The above refers to a simple business entity with one owner – a sole proprietorship. Entities can be expanded further to obtain more capital, such as partnerships, with two or more owners, or partners. Larger still will be companies or corporations which receive capital contributions in the form of shares or stock (by the way, that’s where we get the term ‘stock market’, where people trade stocks of public listed companies). The number of shareholders in corporations is unlimited, and can reach millions.
Within the accounting equation, owner’s equity is located on the right side, together with liabilities.