What is equity?

Business equity will have a few different components worked in, including:

• Stock Price – Amounts paid for preferred stock and common stock will be reported in equity.
• Additional Paid in Capital – This is the amount an investor pays for share capital above the par value.
• Retained Earnings – Past and current year profit or loss are reported in retained earnings in the equity section. Retained earnings will also contain current and past dividends paid to shareholders.

It’s important to note that the business structure you operate under will impact the category names found in the equity section. For example, a sole trader or single-member LLC wouldn’t have stock price or additional paid in capital in the equity section. Instead, they would have member contributions and distributions.

Types of Equity

Equity can take on different meanings depending on the type of investment you are referring to. Let’s look at some of the common types of equity.

Home Equity

Home equity refers to the difference between the market value of your home and the amount remaining on your mortgage loan. Let’s say your home is worth $500,000 and you have a mortgage loan of $250,000 and a home equity line of credit of $50,000. Your total equity, taking into account all home equity loans, will be $200,000.

Private Equity

Private equity refers to the evaluation of a private company, which is one that is not publicly traded on a stock exchange. Determining the private equity you have in a company is done using the accounting equation and calculating the book value of equity by subtracting assets from liabilities. A small business will use the private equity number to attract investors and secure bank loans.

Shareholder Equity

This type of equity refers to an investment in a publicly traded company and can be found using the accounting formula. Shareholder equity will be found on the balance sheet.

Brand Equity

Brand equity is a non-financial factor that evaluates a company’s likeness in the eyes of the public. For example, a consumer might choose to go with a name-brand soda rather than a generic brand due to brand equity. However, brand equity can also take on a negative meaning due to bad publicity.

Health Equity

Health equity is the concept that everyone should have equal access to resources to achieve a healthy lifestyle. For example, making fruits and vegetables more affordable than other types of junk food, especially in underserved communities. Health equity has a similar mission to transportation equity, which seeks fairness in the mobile accessibility community.

Racial Equity

Racial equity also takes on a similar concept to health equity by trying to create equality in races. Racial equity is often associated with civil rights, calling on the Federal government to enact change.

How to Calculate Business Equity

Equity is found on the balance sheet and is one of the main components of the accounting formula. Reversing the accounting formula, we can find equity through the following equation:

Shareholder Equity = Total Assets – Total Liabilities

Let’s say that you have $150,000 in assets and $90,000 in liabilities. Using the above formula, your shareholders’ equity would be $60,000. However, this doesn’t mean that if you liquidated all of your assets and liabilities, you would receive $60,000. Instead, the calculated equity refers to your book value.

Now, let’s say that your total assets contain machinery and equipment that has been fully depreciated. You estimate that you could sell these items for $50,000. If you liquidated everything, you would actually receive $200,000 for your assets, increasing your ownership equity to $110,000.

Adding another layer of complexity is tax equity. Under different types of common law and tax codes, certain income and expense items are non-taxable. This creates a difference between the equity reported on your balance sheet and the tax equity you would have if you sold your ownership percentage.

As a result, many business owners track different types of business equity, including the fair market value of their ownership percentage, their tax equity, and book equity. Understanding differences in these calculations allows you to make more informed decisions.

Evaluating Equity

As a business owner or investor, it’s important to be able to evaluate equity on the balance sheet. The first factor you want to look at is the overall value of equity. A positive equity number indicates that the company has enough assets to cover its liabilities in the event of a liquidation. If the value is negative, it means that shareholders will receive no money in a liquidation. In fact, they may need to contribute more money to satisfy outstanding liabilities.

Next, you want to dive into the specific categories of equity. Start with retained earnings. Is the number a positive or negative? If the number is positive, it can mean that the company has been profitable in the past. However, a negative number indicates the company is either losing money each year or paying out too high of dividends.

Additionally, ratio analysis is a great tool to evaluate equity. Return on equity measures the company’s financial performance by dividing net income by shareholder’s equity. A ratio between 15% and 20% is considered good, while anything less than this stipulates financial issues.

Summary

• Equity is the value of an investment.
• Equity can take on many different forms, including home equity, private equity, shareholder equity, health equity, and racial equity.
• Business equity is calculated using the accounting formula, subtracting assets from liabilities.
• A positive equity indicates strong financial health and the ability to meet upcoming payment obligations, while a negative equity means the business is losing money and operations might not be sustainable in the long term.