UNDERSTANDING ACCOUNTING TALK 14: Borrowing to go into Business

In the basic accounting equation:

Assets = Liabilities + Equity

Equity is where a business starts. There is no business entity (corporation, small business or proprietorship) which starts with a Liability.

The incorporating stockholders or proprietor may have borrowed the money to put into the business as Equity, but this is not the business entity’s liability. It is a personal liability of the stockholder or proprietor. In this case, unless the business earns enough to be able to distribute dividends to the stockholder (so that he can pay for interest and retire the borrowing) or the proprietorship earns enough so that the proprietor can draw from the business without undermining its viability, it is not worthwhile for the stockholder or the proprietor to go into the business.

The Equity of a corporation or an incorporated small business generally consists in: Stockholders’ Equity (or Paid-Up Capital) and Retained Earnings.

The Equity of a proprietorship is the Owner’s Capital or, in the case of partnerships, Partners’ Capital. There is a temporary account which reflects the Drawings of the owner/s or partners.