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:
For businesses, equity can have multiple meanings for the value of their finances. Equity can refer to:
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 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:
Preferred stock differs from common stock with dividends and voting procedures:
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:
To calculate what is equity in business, you first need to determine the value of all the assets:
Next, you’ll subtract assets from all of your liabilities:
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.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. 1-800Accountant assumes no liability for actions taken in reliance upon the information contained herein.