The term “equity” appears on the balance sheet of a company. However, this term is also commonly used in personal finance, accounting, and investing. This blog will explain what is equity, how it is defined, and why it is important for businesses and shareholders. So, let’s start to explore more about equity.
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What is Equity?
The amount of money that can be returned to the shareholders of a company once all the assets are liquidated, and all the debts of a company are paid off is known as equity. In a publicly listed company, equity belongs to every shareholder, and it belongs to the owner in a private limited company.
Equity is the net worth of a business. To work out equity, you must first determine the assets and liabilities of a business.
What are the Assets of a Business?
The things that are owned by a company and that contain value are known as assets. The following can be included in the assets of a business.
- Copyrights, patents, and trademarks
- Accounts receivable
- Buildings, furniture, and land
- Equipment and supplies
What are the liabilities of a Business?
Liabilities are something that is needed to be paid off in the future. The liabilities might include:
- Salaries and wages
- Accounts payable
Now, we will see where does the equity fits into it.
How to Calculate Equity?
The analyst often utilises equity to determine the financial status of a company. The formula for calculating equity is as follows:
Shareholder’s Equity = Total Assets – Total Liabilities
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What are the different forms of Equity?
The following are the different forms of equity:
Ownership Equity – It is the amount of money that remains after paying all the debts to its creditors by a company (when it is proclaimed bankrupt and goes into liquidation).
Stockholders’ Equity – It is the number of funds that are contributed by the shareholders (including profits or losses) on all company balance sheets.
Private Equity – It is any stock or additional securities that shows ownership in a private limited company.
Why Equity is Essential for Small Businesses?
When all liabilities are subtracted from the total assets, consider equity as the valuable part of the business that is left over. If a business has more equity, it is considered to be more valuable.
When you possess shares in a company, you also possess equity and a share of the profits. It means that if your company does well, your profits will increase, as will the value of your equity. Therefore, a private company in need of finances may consider selling its own shares (equities).
What is the Risk of Selling Equity for a Business?
When equities (shares) are sold, the company must share profits with other shareholders. It also means that the ownership of a company is shared too.
If you, as a business owner, want to sell your company’s equity (share), the other shareholders must agree as well. Therefore, sharing ownership may make future changes or decisions more difficult.
We hope now you have a better understanding of what is equity and why it is important to businesses and shareholders. Equity is significant as it shows the financial status of a company, and a business with more equity is considered more valuable. To raise funds, a company can sell its equity (shares), but it must be aware of the risks associated with it.
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Disclaimer: This blog contains general information about what is equity.