What is equity?

What is equity, and why does it matter? If you’re diving into the world of finance or business, understanding equity is a must. It’s a crucial concept that comes up in everything from investments to valuing a business. In this guide, we’ll walk you through:

• Equity definition
• What is an equity share?
• Types of equity
• Components of equity
• How to calculate equity
• The equity formula
• Examples of equity calculations
• Financial reporting
• The importance of equity
• Equity vs other financial metrics
• How Dojo can help
• FAQs

The business bedrock: What is equity in business?

Equity is all about value – it’s what’s left over once you’ve taken care of any debts. In business, it’s the amount that would go back to shareholders if everything the company owns was sold and all the bills were paid.

Ownership 101: What is an equity share?

Equity shares represent owning a part of the company. When you buy an equity share, you’re investing in the business, earning a portion of the profits (typically as dividends), and gaining a voice in important company decisions.

The top three: Types of equity

Owner’s equity

Equity is all about value - it’s what’s left overOwner’s equity is all about the owner’s share of the business – it’s worked out by subtracting total liabilities from total assets and gives business owners a clear picture of their business’s net value.

Private equity

Private equity focuses on investment funds that don’t trade on public exchanges. These funds are often used to invest directly in private companies or to buy out public companies, which are then removed from the stock market. Understanding private equity is key when exploring equity in finance – it plays a major role in funding and growing businesses outside traditional markets.

Brand equity meaning

Brand equity is the added value a brand brings to a product or company. It reflects the brand’s strength, reputation, and the loyalty of its customers. A strong brand equity translates to higher pricing power, dedicated customers, and a competitive advantage in the market.

Inside the numbers: Components of equity

The equity definition is made up of the following components: 

• Outstanding shares: Shares issued by the company and held by investors, representing ownership in the business.
• Additional paid-in capital: The extra amount investors pay above the par value of shares, reflecting additional investments by shareholders.
• Retained earnings: The profits a company keeps instead of distributing as dividends, which are reinvested back into the business.
• Treasury stock: Shares the company has repurchased from investors, reducing total equity as these shares are no longer in the market.

Financial fundamentals: How to calculate equity

The equity formula

The basic equity formula is: equity = total assets − total liabilities

How to calculate equity

To calculate equity in business, simply subtract the total liabilities from the total assets of a company – this calculation provides the net value of the business and insight into its financial health.

Examples of equity calculations

Let’s say a company has the following financial assets and liabilities:

• Total assets: £500,000
• Total liabilities: £300,000

Using the equity formula above, the calculation be: 

Equity = £500,000 − £300,000 = £200,000

Balance sheet basics: Financial reporting

Recording equity in the balance sheet

Equity in business is reported on the balance sheet under shareholders' equity.

When recording equity, navigate to the balance sheet under shareholders' equity. The relevant sections include:

• Common stock: The value of shares issued to investors.
• Additional paid-in capital: Extra funds paid by investors over the stock's face value.
• Retained earnings: Profits kept by the company rather than distributed as dividends.
• Treasury stock: Shares bought back by the company and held in reserve.

Make sure each category is clearly listed with accurate amounts to keep your financial reporting on point.

Reporting equity in financial statements

While equity is reported in the financial statements, mainly in the balance sheet, it’s also shown in the statement of changes in equity. This details the movements in equity during a financial period.

Equity vs owner’s equity vs net worth

So what does equity mean in relation to other metrics? While equity, owner’s equity, and net worth are often used interchangeably, there are some key differences to keep in mind.

Equity in business is what’s left over after you subtract all the liabilities. Owner’s equity focuses specifically on the owner’s share of the business. Net worth is a broader term that works for both businesses and individuals – it’s total assets minus total liabilities.

Building value: The importance of equity

Contribution to financial stability

A strong equity position helps keep a company financially stable – it acts as a safety net during tough times and lowers the need to rely on external debt.

Increasing company value

Equity in business can add value by attracting investors, improving creditworthiness, and fueling growth through reinvested earnings.

Maintaining a healthy equity position

Maintaining a healthy equity position is important for long-term success. Companies, therefore, focus on increasing their equity through profitable operations, careful debt management, and strategic reinvestments.

Comparative metrics: Equity vs other financial metrics

Equity vs return on equity

Return on equity (ROE) measures a company’s profitability by showing how much profit is made with the money shareholders have invested. 

It’s calculated as: 

ROE = net income ÷ shareholder’s equity

Equity vs market capitalisation

Market capitalisation is the total value of a company’s outstanding shares in the stock market. It’s calculated as: 

Market capitalisation = share price × outstanding shares