Equity represents the residual value of a business entity or an asset after the subtraction of all its debt obligations. In the context of a company, equity is the amount of capital contributed by the owners or shareholders, plus any retained earnings. Equity is defined as the residual interest in the total assets of an entity after deducting its liabilities.
Content Outline
How Equity Works
Equity can take various forms, depending on the context:
Shareholder Equity
In a corporation, equity represents the ownership stake of shareholders. It is calculated as the absolute figure from the difference between the total assets of the company and the total liabilities of the company. Shareholder equity can be divided into:
- Common Shares: Represents the number of shares an individual has in a particular company. Common shareholders have voting rights and may receive a share of profit through dividends.
- Preferred Shares: Represents ownership rights where shareholders have priority for dividends and the distribution of assets in the case of the company’s liquidation but without the right to vote.
Owner’s Equity
In sole trader or partnership business, equity means the owner’s or partners’ capital contributions and retained earnings.
Home Equity
In real estate, equity refers to the amount by subtracting the property’s current market price from the remaining balance on the mortgage taken to purchase the property.
How To Calculate Equity
Equity can be calculated using the following formula:
Equity = Assets – Liabilities
- Assets: The company’s resources with economic value.
- Liabilities: The company’s financial obligations.
Example:
If a company has total assets of $100,000 and total liabilities of $60,000, its equity would be:
- Equity = $100,000 – $60,000 = $40,000
Key Takeaways for Equity
Equity is a component of the fundamental accounting equation: Assets = Liabilities + Equity.
Equity is divided into shares, which represent ownership units.
Shareholders are the equity holders and they have certain rights such as the right to vote, the right to earn profits etc.
Summary
Equity is used in measuring ownership and value and it refers to the residual amount of interest that an entity has in the assets after deducting the amount of liability. It is central to various financial situations, whether at the corporate or the individual level, including net worth analysis, and real estate investment. Calculating equity requires the deduction of the total liabilities from total assets.