Equity in Business: What Is It (and Why Does It Matter)? 

Equity. It’s a term that you’ll see thrown around a lot in the business world, but what, exactly, does it mean?

If you’re interested in a career in business, having a solid understanding of equity and what it entails will be essential to your success—not only in school but also in your career.

However, understanding the concept of equity isn’t quite as simple as reading a definition in a textbook. That’s because there are different definitions of equity based on the context (shareholders’ equity vs. owner’s equity, for example), as well as many different forms of equity.

Still, if you want to get a head start on understanding this complex concept as you prepare to embark on a business degree program, we’re breaking down the basics below.

What Is Equity in Business – In Simple Terms?

In its most basic terms, equity refers to the total amount of money that would be returned to the stockholders within a company if the company’s assets were liquidated and all outstanding debts were paid off. It can be helpful to think of equity as a degree of ownership that remains after all debts and payments are subtracted from the value of a business. You can find all this information on a company’s up-to-date balance sheet, so a company should always know where they stand as long as they’re keeping track of their liabilities and assets.

What Is an Example of Business Equity?

To gain a better understanding of business equity and how it works, it can be helpful to look at an example.

Let’s say you started your own business selling t-shirts. The total value of your inventory, cash, and assets related to the business (such as screen-printing equipment) is $10,000.

Meanwhile, you have about $3,000 worth of debt and liabilities in the form of charges to a business credit card that you made when you launched the company. These debts include charges for marketing materials, a business license, and website startup costs.

To calculate your equity in the business, you subtract your debts and liabilities ($3,000) from the total value of your business ($10,000), which gives you $7,000. Congratulations! You have $7,000 worth of equity in your business. Not bad!

Shareholders’ Equity vs. Owner’s Equity

When it comes to understanding the business definition of equity, it’s also important to understand the difference between shareholders’ equity and owner’s equity in a company.

These terms are very similar, but they do have one notable difference. In a corporation that is publicly traded, shareholders’ equity refers to the total amount that the shareholders of the company would be paid if all shares were sold off and outstanding debts and liabilities settled. Owner’s equity, on the other hand, is similar, but only applies to a sole proprietorship. This is often the case when a company is owned by just one individual who holds 100 percent of the preferred stock.

You may sometimes see the terms shareholders’ and owner’s equity used interchangeably. Ultimately, this all boils down to whether the company is publicly traded with many shareholders or if the company is owned by a single entity. Regardless, the calculation for determining equity remains the same.

How Does Equity Work?

Negative Equity

The next step to understanding equity’s meaning in business is to see how it actually works. This requires an understanding of both positive and negative equity, knowing the exact formula to calculate equity, and understanding the ins and outs of equity financing. This knowledge will serve you well if you decide to embark on a business degree program down the road.

Sometimes, the amount of total assets minus total liabilities doesn’t result in a positive number. When there are more liabilities and debts than there are assets at any given time, you are dealing with a negative equity situation.

While negative equity isn’t ideal, it isn’t necessarily a reliable indicator of a company’s financial health—especially when looking at it in the short term. Over time, if a company’s equity remains or becomes even more negative, then shareholders may begin to consider selling their treasury stock because the business may seem like a risky investment that affects their dividends. Ultimately, equity should always be used carefully and in conjunction with other metrics to determine the overall health and viability of a business, rather than as a standalone indicator.

Equity Financing

In some cases, companies will sell shares in exchange for capital. This unique type of financing may be obtained directly through friends or family, third-party investment firms, or even private investors. Regardless of the source, the purpose of equity financing is to obtain quick funds in exchange for a stake in the company. These funds are often used to cover short-term expenses, such as immediate bills. In other cases, funds may be needed to finance a longer-term program.

Equity financing is a viable option for many businesses, but it is most commonly used by startup businesses that don’t want to incur additional debt. With this type of financing, the money doesn’t have to be paid back directly, so there is no financial burden to the business in this sense.

Formula to Calculate Equity

In business school and throughout your career in business, there’s a solid chance you will be tasked with calculating shareholders’ equity or business equity. If you need to do this, be sure to remember this important formula:

Equity = Total assets – Total liabilities

You can typically find the total assets of a business on its balance sheet for the given period. From there, subtract the total liabilities from this number to determine the equity. Keep in mind that you may be asked to calculate equity for different timeframes, as businesses like to track their equity and watch for emerging trends.

Other Forms of Equity

If you’re going into business school, then you will most often be dealing with business equity, including shareholders’ and owners’ equity in your everyday dealings. However, it is important to understand that this is not the only type of equity out there. In addition to business equity, there is also private, real estate, and brand equity. All of these follow the same basic concept, but it’s a good idea to understand the differences between these types of equity as you move forward in your career.

Private

Not all companies are publicly traded, though even privately held companies need to understand what their equity and retained earnings look like at any given time. Enter private equity, which refers essentially to the total book value of a privately held business after its liabilities and debts have been subtracted from its assets.

Being able to calculate private equity is important because many business owners still need to explore investment opportunities and raise capital. Likewise, a privately held company may need to know its equity for insurance purposes.

Home/Real Estate

Another common type of equity that you may run into is that of real estate or home equity. With this type of equity, the calculation usually involves subtracting the total amount that a person owes on their mortgage from the current value of the property itself. For example, if a person’s home is worth $250,000 but they only owe $150,000 on their mortgage, then they have $100,000 worth of equity in their home.

Knowing how much real estate equity you have can come in handy if you’re looking to refinance, thinking about selling, or are even considering applying for a home equity loan to complete some repairs or renovations around the house. Lenders will want to see that you have positive equity on your investment before they determine whether to give you a loan.

Brand

Another more complex type of equity to consider is that of brand equity, which essentially refers to the value that a company is able to generate from having a recognizable name and brand—particularly when that brand name is compared to a more generic version.

When a company has built positive brand equity, they will find that they can charge a little more for their products or services than their competitors. Individuals will pay that “premium” because of the perceived value they associate with the brand and its name.

How Is Equity Used?

With all this information in mind, you may be wondering to yourself why this concept of equity matters so much in the business world. Aren’t there more important figures and metrics to consider?

While it’s true that equity isn’t the end-all-be-all for a business, it is an important metric to track if you want to stay on top of the overall financial health of a company or venture. Shareholders, investors, and business owners alike use equity to make important decisions every day.

By Shareholders/Investors

Stockholders and investors use equity calculations to determine whether they should hold onto their investments or sell them off due to risk. An investment with positive equity may be worth holding onto if its equity continues to grow, yet a stock with negative equity may indicate a high risk. This, in turn, may encourage stockholders to sell off their shares.

A company’s equity is also a factor when it comes to investments and financing. Those considering lending money to a business will want to know whether they have positive or negative equity, as this may impact their perceived risk.

By Businesses

Business owners should always stay on top of their equity, tracking it throughout the year to spot emerging trends as they occur. Equity can give business owners a better sense of how well their businesses are performing, as well as how easy of a time they may have finding investors for any new ventures or projects they are considering. While equity alone isn’t the only metric worth tracking when it comes to a company’s finances, it is certainly among the most important.

Start Your Journey in Business Today

The concept of equity in business can be quite complex, especially once you start breaking down the different types of equity and all the factors that can influence it. You’ll learn more about the ins and outs of equity in business school, but having a basic understanding of the concept will set you up for greater success moving forward.

Still looking for your ideal business school? Bryant & Stratton College is here to help. With numerous business degrees to choose from, ranging from associate to bachelor’s programs, you can be sure to find the option that suits your needs and goals. Whether you’re interested in business management, accounting, digital marketing, or anything in between, our programs could help you launch your future career.

Ready to learn more? Request more information about our business programs by getting in touch with our team today.