A firm's equity is the amount of money that it's owners are entitled to. Not surprisingly, firms want to increase equity on the balance sheet. While this may be difficult in practice, it is relatively simple in theory; a firm can increase equity in on the balance sheet in three distinct ways.
A balance sheet is a financial accounting document that contains three components, assets, liabilities and equity. The left-hand column lists the firm's assets, while the right-hand columns lists its liabilities and equity. The left and right columns must always add up to the same amount, meaning that any change to the a particular element will affect the other elements, as well.
Equity will increase on the balance sheet any time the firm's assets increase more than its liabilities. For example, if a firm is able to increase its revenues by $100,000, but it only increases its liabilities by $20,000, then the equity on the balance sheet will increase by $80,000. Essentially, this means that a firm can increase the equity on the balance sheet if it is able to increase its profits.
A firm can also increase the equity on a balance sheet by decreasing its liabilities without decreasing its assets by as much. For example, if a firm has a debt of $70,000 but it negotiates to settle the debt at a discounted rate of 50 percent, paying only $35,000, then the equity on the balance sheet would increase by $35,000. This is because $35,000 in liabilities would, essentially, be eliminated without needing to pay them.
The simplest way to increase equity on the balance sheet is by issuing stock. Whenever a firm issues stocks, the equity in the firm increases by the amount that has been issued in stock. For example, if a firm had owners' equity of $400,000 and it issued $300,000 in stocks, then the owners' equity would increase to $700,000. Consequently, there would also be an increase of $300,000 in the firm's assets.
- "Financial Accounting: An Introduction to Concepts, Methods and Uses"; Clyde P. Stickney, et al.; 2009
- Ohio State University; The Balance Sheet: What Does It Mean?; Marianne M. Huey
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