What is an equity in business?
An equity in business is the percentage of ownership of a business that is held by a shareholder. Equity is often referred to as the “owner’s stake” “profit share” or “profit interest.”
From accounting perspective, an equity is the product after deducting all liabilities from the total assets.
Another way to look at equity is that it shows the book value of the company. For instance, if all obligations of the business (liabilities) are settled utilizing the assets, then we get the value of the company which is in fact the owner’s stake or equity in the business.
In short, a equity in business means the company’s assets minus its liabilities.
Equity refers to a company’s assets minus its liabilities. If all of the company’s assets are liquidated and debts paid off, the equity represents the amount of money remaining that would be distributed to the business shareholders.
How to calculate the equity of any company
You just need to deduct all liabilities (current and long-term) from the total assets (current and non-current). The result is equity.
You get the total assets and total liabilities from the balance sheet of the company.
However, the balance sheet is quite self-explanatory. You don’t even need to do the above calculation. Because equity is shown separately on the face of the balance sheet.
But you need to understand the rationale, sometimes we need to put together few puzzles to determine the value of the company.
How to calculate the Market value of equity
The market value of the company will not be the same as the book value. Book value is calculated based on the historical information disclosed in the financial statements. Whereas the market value of the company mainly shows the current share price in the stock exchange. Determining the market value of the company is like putting together different puzzles of information to reach to a rationale conclusion. it may include projections of sales, company’s future plans, market reputation, overall industry trend in which the company operates, etc.
Generally the market value of equity of listed companies can be calculated by multiplying Share price with total number of shares.
It’s not easy to determine a valuation for a privately owned company, especially when there’s no publicly traded stock. However, there are various methods by which we can fairly estimate the value of the equity such as Discounted cash flow analysis, compare company’s data with prior years, etc.
How to calculate the equity of an individual
Personal net worth or equity works on the same concept as in the company. We just need to deduct the total obligations (such as debts, outstanding bills, mortgage taken, etc) from the total assets (property, car, bank balance, personal belongings, etc). In this way we can assess the net worth of any individual. We can see that such financial information of any individual is very confidential, therefore, the net worth we see of the richest persons in the internet are reasonable estimates.
Are there chances to have negative equity?
It works either ways. If the total liabilities out weighs the total liabilities, we get the negative shareholder equity. This shows the critical financial condition of the company. If negative equity persists for long the the company moves towards the insolvency and consequently the company gets liquidated. However, the negative equity is not the only parameter to determine the company’s performance. The financial experts use this information along with other tests to determine the accurate financial condition of the company. In fact some risk takers investors consider negative equity as a buying signal to better negotiate the deal. Eventually, they make huge profits once the company turns its equity in positive.
Components of an equity
The two major components of an equity is the capital invested and retained earnings. The former is amount actually invested in the business by the shareholders. Whereas retained earnings represent the portion of the profit retained during the period by the company. Retained earnings are not distributed in the shareholders. Therefore, it is invested in the business to generate more profits. Retained earnings is basically the profits reinvested in the business.
Other Forms of Equity
The concept of equity has applications beyond just evaluating companies. We can more generally think of equity as a degree of ownership in any asset after subtracting all debts associated with that asset.
The concept of equity in different contexts
Equity in real estate refers to the fair market value of the property minus the total amount owes to the lender. It is also known as home equity.
In case of business bankruptcy, the amount left after settling of all liabilities of the company is the net capital or liable capital.
Equity in non-listed companies works in the same way. The only difference arises that the equity is traded privately. Generally, pension funds and institutions invest in non-listed companies. Since the equity is not being traded publicly on therefore, its also called private equity.
Brand Equity
Brand equity is a perceived value of the company which shows the level of trust given by the customers. It has no impact on the financial statements, however, the company enjoys the benefits of having good brand equity in terms of more revenue and profitability.
Equity Vs. Return on Equity (ROE)
ROE is very famous term that we use to calculate the expected profit to be earned on the equity invested in the business. The formula is super simple, we simply divide the income earned on the total equity, we get the return on equity.
What is an equity fund
An equity fund is a type of investment fund that invests in stocks. The fund’s main assets are the stocks itself with some additional cash.
What is an equity portfolio
An equity portfolio is comprised of all the stocks that are bought and sold by investors. This money is used to fund the growth of a business, and eventually makes a profit by selling the shares of the portfolio.
Final Words
Equity is very important term to understand. If you are an investor or business owner, you must know the implications of equity on the overall business. And how the stakeholders perceive the value of the business interpreting the analysis of equity.