A statement of owner's equity, also known as a statement of changes in equity, is a financial document that shows how the equity in a business has changed over a certain period of time. This statement provides a summary of the business's financial performance from the perspective of the equity owners and is an important component of a business's financial statements, alongside the balance sheet and income statement. Typically, it is the second financial statement to be created, after the income statement.

Below is an overview of what business owners should know about statements of owner's equity, including what they contain, how they're used and how to write one.

What's in this article?

• How is a statement of owner's equity used?
  
• How does a statement of owner's equity relate to a cash flow statement?
  
• Key elements of a statement of owner's equity
  
• How to prepare and format a statement of owner's equity
  
• Examples of a statement of owner's equity
  
• Benefits and limitations of statements of owner's equity
  

How is a statement of owner's equity used?

A statement of owner's equity provides a financial overview of all business activities that have a direct effect on the owner's net investment in the business. This document is used for several important purposes, both internally and externally:

• Performance evaluation: This statement lets owners and stakeholders evaluate the business's performance over a set period of time. By examining changes in equity, stakeholders can gauge how well the business is generating value for its owners.

• Investment decisions: Potential and current investors use this statement to understand the business's financial health and make informed decisions about buying, selling or holding their investment.

• Credit analysis: Lenders and creditors review this statement to assess the business's financial stability and ability to repay loans. A growing equity position can indicate a lower risk for creditors.

• Financial analysis: This statement helps financial analysts understand how various business activities, such as earnings retention or distribution policies, affect owner equity.

• Internal planning: Management uses the statement to make key decisions regarding reinvestment in the business, distribution to owners, or other financial strategies to improve the business's growth and stability.

• Tax purposes: This statement can be relevant for tax planning and reporting, particularly for businesses in which taxes are paid on the basis of the owner's personal income.

How does a statement of owner's equity relate to a cash flow statement?

A statement of owner's equity and a cash flow statement are distinct financial statements which offer different perspectives on the financial health of a business. A statement of owner's equity focuses on changes in the equity of the business over a specific period of time, and shows how net income, owner investments and withdrawals have affected the owner's equity. A cash flow statement details a business's inflows and outflows of cash, categorising them into operating, investing and financing activities.

Together, these statements provide a comprehensive view of a business's finances. While the statement of owner's equity shows how business performance and owner transactions affect total equity, and also reflects changes in the net worth of the business, the cash flow statement provides insights into how these and other activities affect the business's cash position. This determines the business's liquidity and financial stability, revealing how well the business generates cash to meet its obligations and fund its operations. Both statements provide important insights for decision-makers and analysts.

Although the focus of these statements differs, some of the figures that they include are connected. Net income affects owner's equity and acts as a starting point on the cash flow statement in the operating activities section. Owner withdrawals (drawings) also affect equity and are usually reflected in the financing activities section of the cash flow statement. A statement of owner's equity provides an overview of changes in equity, but a cash flow statement demonstrates how these changes are reflected in cash movements.

Key elements of a statement of owner's equity

The various elements of a statement of owner's equity show how business activities during an accounting period have affected the owner's equity. Stakeholders can use this information to assess financial performance and changes in the owner's investments.

• Beginning owner's equity: This is the equity amount at the start of the accounting period. It represents the owner's interest in the business after all liabilities have been subtracted from the assets.

• Contributed capital: These are additional investments that the owner has made during the accounting period.

• Net income: This is the business's earnings after all expenses (including taxes and interest) have been deducted from the revenues. It is the profit that the business has generated during the period. The net income from the income statement is added to the owner's equity.

• Owner's withdrawals (drawings): This is the amount of money or value taken out of the business by the owner for personal use during the accounting period. Withdrawals reduce the owner's equity because they represent assets that are taken out of the business.

• Other adjustments: These are adjustments that affect the owner's equity but don't fit neatly into the other categories. They might include changes in accounting policies or corrections of errors.

• Ending owner's equity: This is the owner's interest in the business at the end of the accounting period. It's calculated by taking the beginning equity, adding the contributed capital and net income, and subtracting any withdrawals and adjustments.

How to prepare and format a statement of owner's equity

Step 1: Title and heading

• Title: The document should be entitled "Statement of owner's equity" to identify its purpose clearly.

• Heading: Include the name of the business and the period covered by the statement (e.g. "For the year ending 31 December 2024").

Step 2: Beginning owner's equity

• Beginning owner's equity: This figure is the ending owner's equity from the previous accounting period.
  

Step 3: Additions to equity

• Contributed capital: List any investments or additional capital that the owner has contributed during the accounting period.

• Net income: List the net income from the income statement. This income increases the owner's equity. If the business has incurred a loss, this will decrease the owner's equity.

Step 4: Deductions from equity

• Owner's withdrawals: List any withdrawals or distributions that the owner has made. This decreases the owner's equity.
  

Step 5: Ending owner's equity

• Ending owner's equity: Calculate the ending owner's equity by adding contributions and net income to the beginning equity, before subtracting any withdrawals or losses. Here's an example of how to calculate this:
  

£50,000 (beginning equity) + £30,000 (net income) - £10,000 (withdrawals) = £70,000 (ending equity)

Formatting

• Line items: Represent each of the above elements as a separate line item.

• Alignment: Align all numerical figures on the right-hand side of the page.

• Subtotals: Provide subtotals after each section.

• Final result: Clearly label and distinguish the concluding figure, the ending owner's equity.

Examples of a statement of owner's equity

Below are examples of a statement of owner's equity for two hypothetical small businesses: ABC Consulting and XYZ Design Studio. These examples illustrate how the statement is structured based on different financial activities throughout the year.

Example 1: ABC Consulting

ABC Consulting
Statement of owner's equity
For the year ending 31 December 2024

Beginning owner's equity, 1 January 2024: £50,000
Add: Net income for the year: £30,000
Subtract: Owner's withdrawals: £10,000
Ending owner's equity, 31 December 2024: £70,000

Example 2: XYZ Design Studio

XYZ Design Studio
Statement of owner's equity
For the year ending 31 December 2024

• Beginning owner's equity, 1 January 2024: £80,000
  
• Add: Contributed capital during the year: £20,000
  
• Add: Net income for the year: £40,000
  
• Subtract: Owner's withdrawals: £25,000
  
• Ending owner's equity, 31 December 2024: £115,000
  

Benefits and limitations of statements of owner's equity

Benefits

• Owner insight: The statement offers business owners a clear overview of their financial interest in the business, showing how business operations and decisions have affected their equity. This information can affect decisions about whether to reinvest profits or withdraw earnings.

• Performance tracking: The statement can track financial performance over time, showing how retained earnings and additional investments contribute to the growth of owner's equity.

• Investor decisions: Potential investors can use this statement to determine the financial health and stability of a business, thereby informing their investment decisions.

• Financial transparency: This statement provides transparency in financial reporting by showing how profits are retained in the business or distributed to the owners. This is important for internal and external stakeholders.

Limitations

• Scope: Although the statement provides valuable information about changes in equity, it does not offer a complete picture of a business's financial health and must be interpreted in conjunction with other financial statements.

• Timing: As with all financial statements, the statement of owner's equity presents historical data. Although this information is valuable, it may not always reflect the current or future financial condition of the business.

• Administrative burden: Preparing this statement can be time-consuming, particularly for businesses that have multiple types of equity accounts or frequent changes in equity.