You must be good at finance if you want to run your own business. Lots of financial understanding you must be acquainted with if you are a newbie in the corporate world. A newbie needs to have a clear understanding of what he is doing in terms of finance and needs to have a thorough understanding of business finance. In the process of making a newbie better at finance, this article will introduce you to a complete guide on “Equity in business”.Equity in business can be defined in simpler terms as the amount returned to the company’s stockholders after all its assets are liquidated and no debts remain.
What is Equity in a Business?
When it comes to the word equity, it is the value of the assets of a business that is left after deducting the value of all the liabilities which the business has. It is basically the value of the business which is left after all the debts, loans and advances are paid off and settled. Now, if we talk more precisely, equity is the sum of all assets plus the net earnings of the business for the specific financial year minus drawings made by the proprietor minus all the loans, advances and other liabilities of the business.
Business Equity = liabilities – Assets
We must also know that Assets are items of value, which are used for the furtherance and prosperity of the business such as inventory or stock, building, land, machinery, patents, goodwill, debtors. Assets can be tangible or intangible. Tangible assets are those which can be touched or felt like the building, land, etc… whereas intangible assets are those which cannot be seen or touched like goodwill, trademark, etc…
ASSETS = LIABILITIES + EQUITY
Liabilities are debts the business owns to other businesses, organizations. The loans and advances are taken by the business from banks or other financial institutions. Some other examples of liabilities are the creditors of the company, the outstanding expenses, etc…Assets can be fixed, current or noncurrent. Liabilities can also be current and noncurrent.
LIABILITIES = ASSETS – EQUITY
Clearly put, Equity is also commonly referred to as shareholder equity, which represents the amount of money that would be returned to the shareholders of the company, if the company was liquidated, all the assets were sold and the debts loans and liabilities were paid off. Equity gives us the true and fair picture of the business about its progress, profitability, and prosperity. It is used by financial analysts to analyze and depict the financial position and financial health of the company.
The companies in which the shareholders are the stakeholders of the company, equity represents the investor’s stake in the company. Their stake is represented by the shares they hold. The shareholders have interests in the company, investing in these companies leads to profits, capital gains and dividends to the stakeholders.
A business can be a single person or multi-person. Equity in a company changes in a multi-partner business if one partner withdraws money or pays a dividend to the shareholders.
The main component of shareholder equity is retained earnings of the business. Retained earnings are part of profits earned by the business in past years which was not distributed among the shareholders. Retained earnings increase on year on year basis because the companies keep re-investing some amount of profits without distributing it among the shareholders.
Similarly, buyback of its own shares in the market also forms a part of equity. The company does this in order to save its name and fame in the market when it cannot provide desired returns to the stakeholders of the company. It can reissue these shares to the public when the company is in need of money.
Types of Equity
Specifically said, if you incur more liabilities, your equity decreases and if you gain additional assets your equity will increase. Equity can be positive as well as negative. If the value of your assets exceeds the value of your liabilities, the company gets positive equity and if the value of liabilities exceeds the value of your assets, the company has negative equity.
There are different types of equity accounts you can open. Common stock is the initial investment that was contributed to the corporation for ownership. Paid in capitals is the excess dollar amounts of shareholders contributed. Treasure stock is used to downsize the company investors and reduce equity in the business. Some others are Preferred stock, Contributed surplus, Retained earnings, other comprehensive earning. These are the several types of accounts used for recording shareholder’s equity. They are commonly used in corporations.
Utilization Of Equity
Equity form a major source of fund for the business. Equity is also used for the purchase of new assets. It is utilized for buyback of shares in the market when the company finds it fruitful. It is also used for the preliminary activities undertaken by the business.
Equity is an important financial term that the newbie should get hold of. If he understands the utilization and concept of equity he can make a handful amount of money in his own business. I hope after reading this article you get a clear understanding of what “Equity” means in the business domain. You will be able to understand the ownership of assets in your own business. As a result, you will make mindful decisions in the near future.