If you’re a small business or startup trying to attract investors, you will likely need to prepare and submit a retained earnings report, often referred to as a statement of owner’s equity. In this article, we’ll take a closer look at what a statement of owner’s equity includes, why it’s important, and how the report should be prepared.
What is a statement of owner’s equity?
A statement of owner’s equity is a report detailing changes in company equity over a specific accounting period or the total value of assets held by the company after deducting all liabilities.
Generally speaking, owner’s equity is calculated by subtracting net loss and withdrawals from net income and capital contributions. When profits outweigh losses, the owner’s equity will be positive; when losses outweigh profits, the owner’s equity will be negative.
Owner’s equity statements are primarily used by privately held businesses, most commonly sole proprietorships or LLCs. Publicly traded corporations, on the other hand, will typically need to prepare a stockholder’s equity or shareholder’s equity statement, a more complex financial statement that factors in components such as stock distributions and dividend payments.
Why would a business need a statement of owner’s equity?
Naturally, having insight into a business’s performance will be important to existing and potential lenders and investors. When a company takes a loss, the statement of owner’s equity serves to illustrate the cause of the loss, and helps investors determine if they can expect more losses in the future; when a company turns a profit, the statement reveals the cause of the profit and helps investors determine if that growth will be sustainable in the long term.
For business owners, an owner’s equity statement can be an effective tool to inform future decision-making. For example, if a business experiences a net loss, understanding when, where, and how those losses occurred can help to reveal what adjustments need to be made to reduce liabilities over the next accounting period.
Four key components to a statement of owner’s equity
For most small businesses and startups, a statement of owner's equity will be calculated using four key components:
The opening or beginning equity balance is the total value of assets at the beginning of an accounting period, before adding income and subtracting liabilities.
Net income/owner contributions
Once the opening balance has been established, business owners must add net income, or the total profit after taxes and business expenses, in addition to owner contributions, or capital invested into the company during the accounting period. The result of this calculation represents the company’s total assets before subtracting liabilities.
After adding net income and owner contributions to the opening balance, business owners must then subtract all losses incurred for the accounting period, including capital withdrawn by the owner to cover business expenses. The result of this calculation represents the company’s total liabilities.
Once the above calculations have been made, the company’s total liabilities are subtracted from the total assets to reveal the ending equity balance or total retained earnings for the accounting period.
How to format an owner’s equity statement
A statement of owner’s equity is most commonly prepared as a one-page report utilizing a fairly straightforward format. The first step will be to create the heading of the statement, which includes three components and should be presented as follows:
Following the statement heading will be a clear presentation of all relevant financial information in spreadsheet format, beginning with the opening balance, followed by the addition of assets, the subtraction of liabilities, and concluding with the ending equity balance. Here is an example of how these values might be presented in a statement of owner’s equity in which the ending balance is positive:
Importantly, to produce an accurate retained earnings report, you will need to be able to develop, analyze, and refer to other key financial statements, such as an income or profit and loss (P&L) statement.
Financial statement checklist for startups
If you’re just getting started as a small business or startup, you will need to develop a team and processes around financial planning and analysis (FP&A), which will help to streamline the production of at least four key financial statements. Here’s a brief look at three other statements you will need to prepare as your business gets off the ground:
An income statement, or profit and loss (P&L) statement, is a report detailing how much revenue your company earned (or lost) over an accounting period. In order to land on an accurate read of P&L, you will need to calculate based on a variety of other factors, including recurring costs and operating expenses. Income statements are critical because they get down to the bottom line of how well your business is currently performing in terms of revenue generation.
Statement of cash flows
Whereas an income statement reveals how much profit your company made over an accounting period, a cash flow statement details changes to inflows and outflows of cash, revealing how cash is both generated and used across your organization. Typically, cash flow statements are broken down to address cash flow related to operating activities, investing activities, and financing activities, and can be useful for informing investors and lenders of how effective your company is at managing its budget.
Prepared on a monthly or quarterly basis, a balance sheet is essentially a snapshot of the overall financial health of your business, as represented by total assets, liabilities, and the value of owner’s equity. In order for your finances to be truly “balanced,” the total assets should be equal to the combined value of liabilities and equity invested into the business. Beyond being important to investors, a balance sheet is an effective tool for business owners to evaluate their financial condition and determine how funds should (or shouldn’t) be allocated.
Gain visibility into cash flow and spend with Ramp
Preparing a statement of owner's equity requires optimal visibility into the movement of cash flow and how funds are being spent within your company. This can be challenging for businesses that still rely on outdated processes to track and manage their finances, and often results in an unnecessary strain on valuable resources.
To simplify this process, Ramp has created a single platform that brings cohesion to the full spectrum of accounting activities across an organization. Through the use of modernized, automated accounting and spend control tools, Ramp helps businesses obtain unparalleled visibility into cash flow and spend, dramatically reducing the time and effort it takes to produce key financial statements and reports.
Businesses that previously spent weeks closing their books now do so in just over an hour using the Ramp platform. And beyond merely speeding up the process, our accounting automation software is designed to significantly reduce the possibility of human error, producing hyper-accurate calculations based on verified transactions and receipts, and updating balances in real-time.
If you want to learn more about how Ramp can help you prepare key financial statements like a retained earnings report, click here to explore our accounting solutions and get started on the platform for free.