Net equity is the second of our “Triple Bottom Lines”, and tells the business owner how strong and safe their company is. Perhaps more importantly, when compared over time, it indicates whether their business is getting stronger and safer or weaker and closer to going out of business.
For most people, net equity sounds like a foreign language, but many of us can relate to this figure if we compare it to the equity we have in our own homes. For instance, if I own a house that’s valued at $500,000 and my loan amount is $300,000, then the equity I have in it is $200,000. If I pay down my loan to $250,000, I’ve increased the equity by $50,000. Doing so lowers the chance that my home will be repossessed, and shows increasing strength and safety for me as the owner.
The net equity of a business is really no different. Like home equity, the figure represents the assets minus the liabilities. If a business’ total assets, such as cash, inventory, equipment, owned property and such equals $750,000 and its liabilities that include payables, debt, employee accrued vacation time and such totals $300,000, than the company’s net equity is $450,000.
So, in a business how do you control net equity? It’s really simple. Either you increase assets or decrease liabilities. Every month that a business makes a profit and retains that hard earned cash in the business, it is increasing net equity, because that business now has more cash and assets than it did the month before.
When studying net equity, I like a simple green arrow up (if net equity increased) or a red arrow down (if net equity decreased). For most business owners, this is all you need to know, because, if you are getting stronger and safer (green arrow up) that is a good thing; however, if your net equity is decreasing (red arrow down), then you need to look into why net equity decreased and reverse that trend quickly.
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