What Is Equity in Business and How Do You Calculate It?
- Human Resources
6 min. Read
Last Updated: 11/09/2023
Table of Contents
Understanding equity in business should be a top priority for business owners and CEOs. Simply put, business equity represents the amount of money (or percentage of interest of ownership) in a company. Owner's equity and shareholder's equity, often used interchangeably, refer to the funds an owner or investor has placed in the organization.
What Is Equity in Business?
Equity in business is most often the key factor by which analysts determine a company's financial well-being.
How does business equity work? Accurate information on a company's equity status can be found in its balance sheets. This document is intended to convey a business's "big picture" overview and an in-depth rendering of assets and liabilities. The simplest way to calculate equity is by subtracting all liabilities from all assets on the balance sheet; what you are left with is your company's equity that can be returned to shareholders, as appropriate.
What does it mean to have equity in business? Equity is useful in pursuing strategic growth and strengthening your position when it's necessary to acquire bank loans or lines of credit.
What Are Examples of Equity in Business?
There are numerous business equity examples to consider. These range from money investors put into a business to stock shares a company purchases back from its investors. Types of business equity include:
Shareholders’ Equity in Business
Shareholders’ equity refers to a company’s providing assets to shareholders (investors, employees, venture capitalists, etc.) after deducting liabilities. This equity structure is commonly associated with corporations.
Owner's Equity in Business
This type of equity occurs in businesses with a sole proprietor. It describes what an owner can claim if and when their business is sold and liabilities have been paid.
Also known as common shares, this form of company equity refers to specific rights shareholders have to various assets. Owners of common stock generally have voting rights towards board elections, appointments of corporate offers, governing, and policies.
Preferred stock resembles common stock, with some key differentiators. Preferred shareholders receive dividends from a business's assets and earnings on a set schedule, and do not have voting rights. Preferred shareholders have priority over common stockholders when it comes to dividends.
This describes stock shares a company purchases back from investors. Typically, this is a "negative" form of equity since the money used to purchase these shares must be deducted from a company's overall equity.
Each business operates under different circumstances. Therefore, business owners should look at the various forms of business equity before determining what is most applicable.
How Does Equity in a Business Work?
A thorough evaluation of assets and liabilities will yield a broad overview of a company's financial well-being. This information can be used (hopefully favorably) by industry analysts and investors.
And because certain assets can be translated into working capital, a business with a strong underpinning may be able to move forward with planned growth, purchase needed equipment and digital technology, and finance internal operations.
Whether a business is in the startup phase, well established, or looking into the purchase of other businesses, business equity is the foundation upon which future growth depends.
How Do You Calculate Business Equity?
Even if you're not a financial expert, knowing how to calculate equity in business is fairly straightforward:
Equity equals total assets minus total liabilities.
Another way of putting this is that business equity indicates the funds that would be returned to shareholders if a company's assets are liquidated, and liabilities have been paid in full.
Where can you find this information? Again, the simple answer is your company's balance sheet. This document should include all your company’s assets and liabilities.
Assets generally include:
- Accounts receivable
- Cash equivalents
These assets are regarded as "liquid," meaning they can be easily converted into cash.
Long-term assets can encompass physical structures, technology and other equipment, and, where appropriate, intellectual property. Note that real estate and intangible assets such as customer loyalty, databases, patents, and other company-owned intellectual property are not generally considered to be liquid assets.
Liabilities (usually regarded as debts incurred by the business) generally include:
- Accounts payable
- Deferred revenue
- Lines of credit
- Financial obligations, short- and long-term
- Rent, utilities, taxes
The money a business owes to banks, suppliers, employees, mortgages, etc., is regarded as business liability.
Make Sure Your Financials Are Sound
Some business leaders leave the accounting responsibilities to others so as not to get mired down in day-to-day financial operations. There's nothing wrong with that, provided C-suite executives fully grasp what equity is and the overall state of a company's financial health. Using a simple equation (total assets minus total liabilities), it's possible for everyone within the organization to better understand the challenges ahead and how well the business is performing.
Remember, there are many stakeholders in the business, and all of them (including investors and, in some cases, employees) pay close attention to the amount of equity a business can claim. Greater equity means more opportunities to grow the business, design better employee benefits to attract and retain new talent, and keep payroll processing and other vital operations running smoothly.