The Sunday Mail
Entrepreneurship Matters
Dr Kudzanai Vere
As we go about our business on a daily basis, a grounded understanding of the things that we do, how we do, and why we do them is crucial. You can only be better and improve at personal and business level if you do things from an informed position.
In as much as some have a mistily understanding of their net position or owner’s equity in business, the majority doesn’t even have a clue. Knowledge of owner’s equity in business introduces you to the reality and awakens you to critical business facets that are building blocks to owner’s equity and to actually concentrate and guard them jealously.
In simple terms, owner’s equity is what remains as yours after having taken care of or paid all your obligations as a person and as a business. Your total assets figure is derived from adding your cash, stocks, tangibles and intangibles. But when we then talk about owner’s equity, we’re now examining the things that you own removing the component that you owe other people from there.
You might have borrowed cash to buy stocks and have gotten some stocks on credit and used some of the cash to buy a delivery van to enhance your operations. All these are put in your company name even the stocks and the vehicle registration book, but when we talk of owner’s equity, we’re squeezing all that you have of the debt component to determine what’s really yours.
An easy way will be assuming closure of business today, what is it that will be left as yours. That’s the thinking behind the calculation of owner’s equity.
The formula to determine your owner’s equity is;
Owner’s equity = Total Assets (Cash, Inventory, Debtors, Prepayments, Positive Bank Balances, Property plant and equipment, good will, patents and trademarks) — Liabilities (Creditors, Accruals, short and long term loans).
Understanding this equation will give you an insight into areas that you need to concentrate on if you are to grow your business. The relationship between debt and equity in your business is known as your gearing ratio. Let me speak into the components of owner’s equity or net worth of your business.
Components of owner’s equity explained
Assets
An asset is typically a resource that is owned and controlled by an individual, company or government with the expectation that it will generate positive economic benefit. Common types of assets include non-current, physical, intangible, operating and non-operating. As mentioned before, some of the general being your cash, debtors, prepayments, bank balance (positive), inventory, fixtures and fittings, investments, good will, patents and trademarks. I will just explain a few here for the purposes of this publication.
Cash
This is what circulates within your business daily which we can easily convert into stocks, use to settle our bills and other obligations. Cash must be guarded jealously for it is just ready for use without any further conversation, refinement or processing. This is why it is prone to abuse in organisations.
Cash equivalents
You might have come across this word in your literature, these are near cash items within our business. Things that can be easily converted into cash in an arm’s length transaction. They take the form of stocks, debtors, prepayments, convertible securities and others.
Those that are shallow in business always take a lackadaisical approach on the cash equivalent as they don’t see liquid cash in them to the extent of failing to institute enough controls to secure these cash equivalents. They were called cash equivalents to make you see that they are almost cash. Treat them the same way you treat your cash.
Debtors
These arise from disposing of our stocks on credit. Ordinarily, we must be selling our products or services on cash basis, but there are circumstances where we see ourselves extending a credit facility to our customers and by so doing we are creating a debtor.
Most of the debtors have a tendency of delaying payments which will end up suffocating our business as we would want to invest back the money in stocks, pay our overheads and even invest in other business ventures. So if the money takes longer than expected or even takes forever to be paid back (bad debts) this means we have lost some profits and value. In business, it is either you have the cash, stock, a debtor or you have paid a creditor or an expense item for the owners’ equity to decline.
Inventory
Popularly known as stock is the basis of the business. Without stocks, you don’t have anything to sell that is if your business involves products, in the service industry, it is a difference story altogether.
Inventory represents value held in products that can be converted any time into money through sales or being manufactured into finished goods in the event of it being some raw materials. If you are in the groceries business, the groceries for sale becomes your inventory.
Liabilities
A liability is a financial obligation of a company that results in the company’s future sacrifices of economic benefits to other entities or businesses. A liability can be an alternative to equity as a source of a company’s financing. Moreover, some liabilities, such as accounts payable or income taxes payable, are essential parts of day-to-day business
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How much is yours in a business?
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operations.
We have two major classifications of liabilities
Long-term liabilities
Long-term liabilities are those that are due after more than one year. It is important that the long-term liabilities exclude the amounts that are due in the short-term, such as interest payable. Examples are loans payable within a period exceeding one year.
Long-term liabilities can be a source of financing, as well as refer to amounts that arise from business operations. For example, bonds or mortgages can be used to finance the company’s projects that require a large amount of financing. Liabilities are critical to understanding the overall liquidity and capital structure of a company.
Short term liabilities
Short-term liabilities are legal obligations which arise upon the receipt of goods or services. In governmental fund type accounts, short-term liabilities are payable from current, available resources. In proprietary fund type accounts, short-term liabilities are obligations payable within one year.
In business, these takes the form of trade accounts payables, accrued expenses, taxes payable, dividends payable, customer deposits and short-term debt
Conclusion
The value of the owner’s equity is increased when the owner or owners (in the case of a partnership) increase the amount of their capital contribution. Also, higher profits through increased sales or decreased expenses increase the amount of owner’s equity.
The owner can lower the amount of equity by making withdrawals. The withdrawals are considered capital gains, and the owner must pay capital gains tax depending on the amount withdrawn. Another way of lowering owner’s equity is by taking a loan to purchase an asset for the business, which is recorded as a liability on the balance sheet.
The value of owner’s equity may be positive or negative. A negative owner’s equity occurs when the value of liabilities exceeds the value of assets. Some of the reasons that may cause the amount of equity to change include a shift in the value of assets vis-a-vis the value of liabilities, share repurchase, and asset depreciation.
The writer, Dr Kudzanai Vere is the founder and CEO of Kudfort Zimbabwe, a fast growing accounting and business advisory firm that has assisted individuals and organizations start, support, sustain and succeed in their businesses through company registration, establishment of standard operating procedures (SOPS), basic book keeping, accounting, auditing, forensic accounting, PRAZ registration, business health checkups and business advisory services. Dr Vere authored a number of business and personal development books that have transformed minds. You can contact Dr Vere on +263 719 592232 or [email protected]
