What is Equity? Definition, Types and How to Count

Equity is one of the most common ways that analysts use, to judge the financial health of a business. In a company's balance sheet, the difference between its liabilities and assets shows how much equity the company has. Investors who set the price of shares as their value, become a reference for the value of equity.

Are you interested in learning more about equity? Check out the following article, OK!

Definition of Equity

Equity refers to the shareholding held by an individual or entity in a company or property. Equity represents the remainder in assets after deducting liabilities. In simpler terms, equity represents the portion that belongs to the owner or shareholder.

In a business context, equity is often associated with shares or ownership in a company. When someone buys stock in a company, he or she acquires equity in the company and becomes a shareholder. The number of shares they own determines their share of ownership and the amount of equity they hold.

Equity represents claims on company assets and earnings. Shareholders who own equity in a company have certain rights, such as voting rights in company affairs and the right to receive a share of the company's profits, known as dividends. If the company is sold or liquidated, the shareholders may also be entitled to a portion of the proceeds from the sale.

Equity is an important concept in finance and investing. Equity is often used to assess the value and financial health of a company. A company's equity position can be evaluated through metrics such as equity ratio (equity divided by total assets) or return on equity (net profit divided by equity).

In the area of ​​personal finance, equity can refer to the value of an asset an individual owns, such as equity in a home. Home equity is that part of the property that is actually owned by the homeowner, excluding any mortgages or loans secured by the property. Homeowners can leverage their home equity to obtain a loan or line of credit, which is often referred to as a home equity loan.

Equity can also be seen in the context of social justice and fairness. In this case, equity emphasizes the principles of fairness and equal opportunity.

Type of Equity

There are various types of equity, the following is an explanation of the various types of equity.

Owner's Equity

The term owner's equity usually refers to sole proprietorships (one-owner businesses) and partnerships. Unlike businesses with multiple shareholders, sole proprietors and partnerships assume total ownership of the business.

It is the owner's claim for whatever is left if the business is sold out, or all liabilities are paid. The calculation of owner's equity is the same as shareholder's equity.

Shareholder Equity

Owner's equity refers to sole proprietorships and partnerships, whereas shareholder's equity almost always refers to multiple shareholders. In this case, multiple investors own shares in the company - meaning the business owner does not own 100% equity ownership.

There are many types of shareholders. Some are equity investors - publicly traded companies may issue equity (in the form of shares) to raise capital and fund growth. Others are business employees who offer equity as a form of compensation.

Private investors, such as angel investors and venture capitalists (VCs), will also seek equity in return for funding. In any case, if the business is sold or liquidated, the shareholders will receive the remainder.

How to Calculate Equity

To calculate equity, the formula is:

Equity = Assets - Liabilities

Some common assets include:

• Cash
• Accounts receivable
• Supply
• Raw material
• Property, plant and equipment
• Trademarks and patents

Some common liabilities include:

• Accounts payable (AP)
• Taxes to be paid
• Loan
• Bank debt
• Mortgage debt
• Wages owed

Note that this formula includes both current (eg, cash) and non-current (eg, long-term debt) assets and liabilities.

How to Calculate Shareholder Equity

In general, owner's equity and shareholder's equity have the same formula. However, some investors use an alternative formula for calculating shareholder equity called the capital stock method. Here's the formula:

Shareholders Equity = Share Capital + Retained Earnings - Treasury Shares

Share capital represents the money that a company earns through the issuance of common stock or preferred stock. Retained earnings are the company's cumulative profit after calculating dividends.

If a company earns $7 in net profit and distributes $2 in dividends, it will have $5 in retained earnings. Treasury stock, also known as treasury stock, occurs when a company buys back outstanding shares.

Companies can buy back stock for a variety of reasons, including consolidating ownership and influencing share price.

Well, that's an explanation of equity. If you want to calculate the amount of equity, don't forget to use the existing formula, OK!