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Owner Equity
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Owner Equity / Capital


At the end of the year, the owner equity can be negative.
A lot of entrepreneurs wonder how this is possible.
And is a negative equity even allowed or is it simply a mistake?

A negative equity is technically possible.
Usually, a negative equity is an indicator of a business problem or posting error.

As a reminder: your balance sheet consists of assets (things you own), liabilities (debts)
and Equity (the capital the owner provided).
Assets are placed on the left side of your balance sheets.
The liabilities and equity are placed on the right hand side of the balance sheet.

The total amount of all your assets must match the total amount of liabilities
and equity: Assets = Liabilities + Equity.
The assets of the company are financed by either owner capital (equity) or debts.

Let's first see how a negative equity can occur in your accounting system.




Negative Equity


Assume that we started a new company without any owner capital or bank funds.
However, the bank does provide us a credit of 100 euro.
We use this credit to buy goods with a total value of 100 euro.
This is what the balance sheet looks like after the purchase of the goods:

Assets:
Inventory, Debit: 100
Company Bank Account, Debit: -100

Total Assets: 0
Total Liabilities + Equity: 0

Note: our bank account is an asset and appears on the left side of the balance sheet.
A negative amount on this account is allowed. A negative amount indicates that we
have used our credit.

Assume that we sell the goods for 50 euro in cash.
We make a loss on this sale.
After the sale, the balance sheet looks like this:

Assets:
Cash, Debit: 50
Company Bank Account, Debit: -100

Liabilities + Equity:
Running Profit, Credit: -50

Total Assets: -50
Total Liabilities + Equity: -50

Account Running Profit is part of the company's Equity.
This sale led to a negative equity.

In this case, it's obvious what caused the negative equity.
We made a loss on the sale and the goods were financed with a
credit from the bank.

The negative equity is *not* an error in your accounting data.

The owner may also have an explanation for this loss.
The goods in this example could be damaged or have become technically obsolete.
Example: every 18 months, faster and better computers appear on the market which makes
existing computers obsolete. The current stock loses its value.
This stock can only be sold with a loss.




Posting errors


A negative equity is rarely the result of posting errors.
In this example, the user could have meant to use 150 euro, but erroneously
specified 50 euro.

In this example, you can easily spot the posting error, but some users use
API connectors or import data from CSV files.
These users can forget to include certain amounts in their data import.
In this case the negative equity is an indicator of data import errors and further
investigation is required to find the cause of the problem.




Write Offs


A negative equity could also result from write offs that occur in a year where
we made a loss. You often make a loss in times of economic recession, but a company
is always allowed to write off on purchased assets.
These additional write offs (which are additional costs) can lead to a negative equity amount.

In this example, we assume that we bought office equipment in the past for a
total of 500 euro. We've already written off 400 euro which results in the following
balance sheet at the start of the year:

Assets:
Office Equipment, Debit: 100

Liabilities + Equity:
Equity, Credit: 100

Total Assets: 100
Total Liabilities + Equity: 100

We decide to run a marketing campaign to gain more attention for our services.
We use our bank credit to finance the campaign. The campaign costs 50 euro.
After registering the costs, the balance sheet looks like this:

Assets:
Office Equipment, Debit: 100
Company Bank Account, Debit: -50

Liabilities + Equity:
Equity, Credit: 100
Running Profit, Credit: -50

Total Assets: 50
Total Liabilities + Equity: 50

Assume that the marketing campaign didn't result in any sales.
Further assume that we decide to write off 20% on our office equipment at the end of the year.
This means that we need to write off 100 euro on our equipment and essentially set the value
of our office assets to zero. After these write offs, the balance sheet looks like:

Assets:
Company Bank Account, Debit: -50

Liabilities + Equity:
Equity, Credit: 100
Running Profit, Credit: -150

Total Assets: -50
Total Liabilities + Equity: -50

The write offs lower our profits even more.

The running profit is part of the company's equity.
The final write off caused the equity to become negative.

In this case, it's advisable to push the write off to next year.





Deposit Equity


The owner (or partners) of a company is responsible for topping off the equity of the company.
In the first example, the owner took out a bank credit of 100 euro and he provided a
personal guarantee to pay the money back.
It's thus logical that he deposits money into the company to remove the negative owner equity.

Note: the owner doesn't have to immediately deposit money back into the company at the start of the new year.
This is customary, but it's not required. You can deposit money any time you want.

The owner can choose to leave the negative equity as is, and wait for the results of the next year.
During the year, it may become increasingly clear that the results of the year will be more than
enough to absorb the loss of the previous year, in which case a deposit is no longer necessary.

In any case, you need to use a transfer voucher if you want to deposit money into the company.

Go to: "Accounting > Transfer Voucher".

Example transfer voucher


Choose: "Owner deposit".
Click on "Save & Post".
The payments are automatically added to the voucher.


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