The Business Definition of Equity
In the world of finance, the term equity generally refers to the value of an ownership interest in a business, such as shares of stock held. On a company's balance sheet, equity is defined as retained earnings, plus the sum of inventory and other assets, and minus liabilities.
For example, if Jennifer has a fleet of cars for her catering business worth $20,000 (her assets) and she has $9,000 left on her fleet loan (her liability) she has $11,000 worth of equity in her business. Jennifer can use this equity in a few different ways, including getting a larger line of credit for her business, and obtaining a lower-interest rate when borrowing money.
6 Forms of Business Equity
As a financial term, equity always represents some type of business value, but has multiple uses when describing the details of ownership.
Equity can mean:
- 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. 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 shares ownership with others (known as shareholders.)
- On a company's balance sheet, total equity is represented by the sum of the following accounts: common stock, preferred stock, paid-in capital, and retained earnings.
- If you're an investor in the stock market, equities are stocks, one of the principal asset classes in your portfolio.
- If you're 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.
- When talking about real estate, equity 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 known as ownership equity.
All the forms of equity listed above share a basic thread: they're each the sum of inventory, assets, and net earnings.
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 $15,000 worth of equipment and 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 worth of equity in his business. If Joe owed more than $15,000 in loans and other debt, his business equity would be negative.
When calculating equity, especially for large corporations, the total value of assets will include both tangible and intangible assets. Tangible assets are physical possessions, like product inventory, facilities, and property; intangible assets include a company's reputation, intellectual property, and brand identity. These intangible qualities are known as brand equity, and they're best illustrated by the difference between a widely-recognized brand and a generic brand.
Intangible equity is built up through years of being in business and successfully servicing your customer base.