- There are two general ways to get money to buy assets.
If you borrow the money, the source of the financing
is called liability.
If the money is invested by the owners,
the source of the financing is called owners' equity.
Now owners' equity is the amount that owners
have invested in a company for the company
then to use to buy assets.
So there are two ways for owners to invest in a business.
One, the simplest way to visualize
is that the owners just say okay, my business needs
some money to buy assets so I'm going to pull the money
out of my personal pocket from my personal savings.
I've done some work elsewhere, I've been prudent,
I've saved my money, I'm now going to pull it out
of my pocket and put it into my business
and the business will then use the invested money
to buy business assets.
We call this paid-in capital which is the amount
that owners take out of their personal savings
and invest in their business.
This amount is also sometimes called capital stock
or capital contributions.
That's one way that owners invest in a business.
Now another way that owners invest in a business
is through retained profits.
When a business generates some income,
who owes the income generated by the business?
Well, the owners do.
The owners can choose what to do with those profits.
Sometimes the owners will say okay, my business generated
some profits and I'm going to take some of those out
to use for personal reasons to pay tuition,
to buy a boat, to do whatever.
We call these distributed profits, dividends.
The amount of dividends represents the amount of profits
that owners have removed from the business.
Now in contrast more often than not,
owners will say okay, my business generated profits,
I'll take out a little bit of dividends,
but most of it I'm going to put back
into the business for expansion.
The business will use these profits
to buy more buildings, to buy more equipment,
to buy more inventory.
Owners can invest directly, we call that paid in capital.
Owners can keep the profits in the business,
we call that retained earnings.
The sum of these two things, paid in capital
and retained earnings is equal to owners' equity.
Liabilities and owners' equity, they are the labels
for the two general sources of financing to buy assets.