What Is Equity in Business and How to Calculate It

For business owners, equity is a vital tool that you can use to your advantage. There are different equity types that serve different purposes within your business. Here’s an overview of what equity is and how to calculate equity in a business.

What does equity mean in business? 

Equity comprises the net value of a business; it’s the result of a company's assets minus its liabilities. The bookkeeping term equity is important because it gives you an idea of: 

• How much the shareholders would receive if they sold their stake in the company 
• Money left over for shareholders following asset liquidation and debt repayment
• The net value of a business

For businesses, equity can have multiple meanings for the value of their finances. Equity can refer to: 

• Balance sheet
• Liquidation
• Real estate 
• Stocks 

When referencing the balance sheet, equity refers to the total of common stock, paid-in capital, preferred stock, and retained earnings. This form of equity is shareholders’ equity.

Equity from liquidation is what remains following a business's bankruptcy and liquidation. 

This form of equity is ownership equity. If your business is in a poor financial state before liquidation, there’s a chance that there won’t be ownership equity following debt repayment.

The third variation of equity in business is real estate. In this instance, equity is what remains after deducting the fair market value of your property from the balance you owe on your mortgage.

Finally, when referring to stocks, equity refers to the ownership interest that a business has. Investors can buy equity shares either as common stock or preferred stock. With stocks, equity represents the amount investors can receive as cash for the share.

What are the different types of equity?

Businesses use different types of equity, which illustrate what business owners, investors, and shareholders can learn about your company. 

There are multiple equity types that a business may use to determine its value:

• Common stock 
• Negative equity
• Positive equity
• Preferred stock
• Retained earnings 
• Treasury stock

Common stock indicates that a person owes shares in a corporation. These shareholders represent an ownership stake in a company that allows them to receive profits from its operations. 

Common stock shareholders receive distributions made by the company through dividends or stock repurchases. As a common stock shareholder, you can: 

• Elect board members with one vote per share 
• Meet with other investors to elect board members
• Vote on major decisions affecting your business, including who sits on its board and what projects it pursues 

Preferred stock differs from common stock with dividends and voting procedures:

• Preferred stock has a set dividend rate, which can be fixed or variable based on company performance 
• These shareholders aren’t able to vote to elect a board of directors or for major company decisions
• This type of stock also allows you to participate in distributions made by the company through dividends or stock repurchases

Businesses can experience positive equity or negative equity. Negative equity is an indicator that a company has more liabilities than assets. Positive equity indicates that a company has sufficient assets to pay its liabilities.

Retained earnings are the percentage of net earnings not paid to shareholders as a dividend. Businesses can use these earnings to pay debts or to reinvest.

Treasury stock represents the number of shares that a business repurchases from investors. On a balance sheet, you’ll list this stock as a negative number within the equity section.

How To Calculate Business Equity in Accounting

Businesses can calculate equity accounting in a few steps: 

• Calculate your total assets 
• Calculate your total liabilities 
• Subtract your total assets from your total liabilities 

To calculate what is equity in business, you first need to determine the value of all the assets:

• This includes current assets and long-term assets 
• Current assets are assets you can convert to cash in a year or less
• Long-term assets are assets that can’t be converted to cash within one year

Next, you’ll subtract assets from all of your liabilities: 

• This includes current liabilities and long-term liabilities 
• Current liabilities are debts owed within one year
• Long-term liabilities are debts that can’t be paid within one year

The resulting number is equity.

Here’s an example of equity: A small business has total assets of $3 million and total liabilities of $500,000. From this, you would deduct the $3 million in total assets from the $500,000 in total liabilities to get an equity of $2.5 million.

How Can You Use Equity To Grow Your Business

If you want to grow your business, but don't have access to the capital required, then equity is an option. As a business owner, there are ways you can use equity for business growth, or you can work with private equity investors for business growth.

Equity allows you to give away part of the ownership of your company for investing. You can then use this money to invest in a new product or service to make more money for both parties involved.

The next way you can use equity for business growth is to work with private equity investors. These investors can work with businesses to propel business growth, and there may be business advantages in doing so. By partnering with private equity investors, you’ll get liquidity. You can also choose to remain invested in your business as well.

Work with a Professional 

Equity can be a useful tool for growing and sustaining business growth over time. It has several uses and provides a good overview of your business value. 

When it’s time to determine your business equity, or receive help for your small business bookkeeping needs, work with the professionals. Work with an accounting professional at 1-800Accountant for all of your bookkeeping and accounting needs.