Why Would Equity Be Negative?
In financial statements, equity represents the difference between assets and liabilitiesâessentially, whatâs âleft overâ for owners. When equity turns negative, it means a companyâs liabilities outweigh its assets. This can raise red flags, but itâs important to understand the why, when, and how to respond.
1. What Is Negative Equity?
Equity = Assets â Liabilities. When this calculation results in a negative number, the company has negative shareholdersâ or ownerâs equity, also called a deficit
On standalone assets like homes or cars, negative equity (also known as being âunderwaterâ) means you owe more on your loan than the assetâs current value .
2. Causes of Negative Equity
A. Accumulated Losses & Deficits
If a company consistently reports net losses, these reduce retained earnings. Over time, this erodes equity until it becomes negative
B. Heavy Borrowing
Taking on debt without balancing it with asset investments increases liabilities faster than assetsâpushing equity downward
C. Dividend Payouts & Share Buybacks
Paying large cash dividends or buying back shares uses retained earnings and cash/assets, reducing equity
D. Amortization and Impairments
Writing down intangible assetsâlike goodwill or patentsâreduces asset value over time, negatively impacting equity .
E. Asset Depreciation
Assets can lose value (e.g., outdated equipment or falling real estate prices), and without offsetting gains, equity may turn negative
.
3. Real-World Examples
Sears had a $3.7âŻbillion negative equity in 2018 due to accumulated deficits, write-downs, and share repurchasesâshortly before its bankruptcy
Homeowners during housing market downturns often owe more than their homes are worthâstatistics show negative equity remains widespread in fluctuating markets
4. What Negative Equity Means for Your Business
Credit and lending challenges: Lenders may distrust firms with negative equity, limiting financing options .
Investor caution: It can signal financial instability or mismanagement, reducing investor appetite .
Operational pressure: Pressure to pay liabilities may divert cash from core investments.
Not insolvent by default: A company can have negative equity but still meet short-term debts; insolvency occurs only when liabilities cannot be paid as they come due .
5. When Negative Equity Can Be Acceptable
Start-Ups & Scaling Companies: Early years may show negative equity due to heavy investment and capital raises
Strategic leverage: Firms may take on debt knowing future profits will offset current negative equity.
Non-cash accounting effects: Large amortization or impairment charges can push equity negative without immediately harming cash flow
6. Q&A on Negative Equity
Q: How can equity be negative but the business still runs?
A: As long as current assets generate enough cash to cover short-term liabilities, operations can continue despite negative equity .
Q: Is negative equity the same as bankruptcy?
A: No. Negative equity means liabilities exceed assets. Insolvency, or inability to pay debts on time, is a more serious condition.
Q: Can I reverse negative equity?
A: Yesâthrough profit growth (restoring retained earnings), asset appreciation, injection of new equity, debt repayment, or reducing liabilities .
Q: Whatâs the difference between negative equity and negative cash flow?
A: Negative equity is on the balance sheet; negative cash flow refers to insufficient operating cash. A company can have one without the other .
Q: Should investors avoid all companies with negative equity?
A: Not necessarily. For young or fast-growing firms, temporary negative equity may be expected. Established firms with persistent negative equity are cause for concern .
7. Best Practices for Businesses
Monitor retained earnings each period; investigate large deficits.
Track debt levels vs assetsâmaintain prudent leverage.
Plan dividend/buyback strategy around healthy reserves.
Watch amortization and impairments, keeping transparency in financial reporting.
Reassess asset values regularly and write them down only when necessary.
Strengthen equity via retained profits, capital raises, debt refinancing, and building reserves.
8. Advanced: Three-Way Financial Modeling
An integrated modelâcombining income statement, balance sheet, and cash flowâhelps you see how operational losses, financing, and investing affect equity trends. This enhances planning and investor credibility.
Call to Action
Is negative equity keeping you up at night?
At Brecken Business Solutions, we specialize in analyzing balance sheets, forecasting equity trends, and implementing turnaround strategies. Letâs review your equity position see where losses, leverage, or payouts may be impacting your net worth, and work together to build financial strength.
Contact us today for a no-obligation equity health check and customized action plan.
References
