The Business Definition of Equity
As it pertains to a person, equity is defined as the quality of being fair and impartial, or equitable. However, in the world of finance and accounting, the term equity generally refers to the value of a group of assets after deducting the value of liabilities, or the value of an ownership interest in a business, such as shares of stock held.
On a company's balance sheet, you might see equity defined as the sum of inventory and other assets, plus earnings minus overhead (called retained earnings), minus loans and other liabilities.
6 Different Forms of Equity in Business
To define equity a bit more specifically, although the term always represents some type of business value, it has multiple uses in describing the specifics of business value in different scenarios:
- An ownership interest in a company as represented by securities or stock. If the owned stock is in a company that's not publicly traded, it's called private equity. Equity means the ownership interest of investors in a business firm. Investors can own equity shares in a firm in the form of common stock or preferred stock. Equity ownership in the firm means that the original business owner no longer owns 100 percent of the firm but shares ownership with others, known as shareholders.
- On a company's balance sheet, its total equity is represented by the sum of the following accounts: common stock, preferred stock, paid-in capital, and retained earnings.
- If you are an investor in the stock market, equities are stocks, one of the principal asset classes in your portfolio.
- If you are an investor in the stock market and engage in margin trading, equity represents the value of securities in a margin account minus what has been borrowed from the brokerage house.
- If you are talking about real estate, equity, or real property value is the difference between the fair market value of the property and the balance owed on the mortgage.
- If your business goes bankrupt and you have to liquidate, the amount of money remaining (if any) after the business repays its creditors is called “ownership equity," or risk capital or liable capital.
Using each of these terms depends on context. All these forms of equity share a basic thread. They each basically equate to the sum of inventory, other assets and net earnings, less overhead, loans, and other liabilities.
Positive and Negative Equity Example
Suppose Joe wants to sell his business, Joe's Excellent Computer Repair. He doesn't own the building he's in, but he does have $10,000 worth of equipment and $5,000 in accounts receivable from his customers. Between his building lease and loans, he owes $5,000. While this is an overly simplistic view, for this example Joe has $10,000 of equity in his business.
Equity can also be negative. If Joe owed more than $15,000 in loans and other debt, his business equity would be negative.
Types of Equity
When calculating equity, and the value of assets, especially for larger companies, these assets may include both tangible and intangible assets. Tangible assets are things you can touch, like inventory or property. Intangible assets may include the company's reputation and brand identity or brand equity.
This kind of equity is built up through years of being in business and successfully servicing your customer base. It is most easily illustrated in the difference between a known brand and a generic brand. When you are shopping, for example, you may reach for a brand-name item because you know and trust it, and not select the generic brand even though it may cost less.