|Accounting formulas are used to measure various aspects of the business, but all of them are derived from one main formula:
Assets = Liabilities + Owner’s Equity
This formula applies to every transaction in accounting and affects each of the financial statements in different ways. For this discussion of the income statement, we can see this formula in action on owners equity.
Earlier we congratulated Sunny for his 2010 profit. Sunny made a net income of $15,283, which directly increased the value of his business.
The following formulas show how net income becomes part of owners equity:
Net Income and Owners Equity
|Net Income = Revenue – Expenses
|Owner’s Equity = Net Income + Investment of Owners – Distribution to Owners|
From this formula we can see that the value of the business, or owners equity, is directly affected by net income as well as investments by owners, either privately or by stockholders.
The amount retained from profits, or net income, is accumulated in the owners equity account.
Corporations have a separate account in the owners equity section called retained earnings. The retained earnings account also represents the net earnings accumulated (retained) or lost from period to period, and may be used to pay dividends to owners. It is a part of owners equity that is listed separately on the corporate balance sheet. The other part of owners equity, as the above formula shows, is investments by owners, and is listed on the corporate balance sheet as:
Corporate Owners Equity
|Investment of Owners|
Sole proprietors have one permanent equity account called owners equity.
Net income profits (or losses) accumulate in the owners equity or retained earnings account from year to year, which directly impacts the value of the company.
Consistent and growing net income truly is the “bottom line” goal of business, since net earnings directly impact the value of your business.
Increasing Owners Equity
|There are two ways to increase the owners equity account: