Equity

Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Equity Meaning

Equity is the net worth of a business. It signifies an investor’s ownership in a company. During liquidation, it is the amount of assets received by the shareholder after paying off liabilities and debt.

It is calculated as the difference between assets and liabilities featured on the balance sheet of a company. It represents a company’s net asset value in front of investors, financiers, and the public. An organization with sound financial health always has positive equity, which means it owns more than it owes.

Key Takeaways

  • Equity is a stake in business ownership; investors can claim the net asset value upon liquidation.
  • A public company can turn its ownership into numerous small units of shares. These are then offered to investors. In doing so, the firm acquires capital to finance its projects.
  • The book value of equity is computed as follows:
    Equity = Total Assets – Total Liabilities.
    Also, the market value of equity is calculated as follows:
    Market Capitalization = No. of Equity Shares Outstanding × Current Market Price Per Share.

Equity

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Equity (wallstreetmojo.com)

How Does Equity Ownership Work?

Equity mirrors a company’s financial health and efficiency in front of the outside world. It signifies the net worth of a business, i.e., the value of assets after paying off all the debts and liabilities. A public company can convert its equity into several small units called shares. These shares are sold to prospective investors. This way, the listed company acquires capital.

When an investor invests in a company’s stake, they become equity shareholders and gain ownership in the firm’s net assetsNet AssetsThe net asset on the balance sheet is the amount by which your total assets exceed your total liabilities and is calculated by simply adding what you own (assets) and subtract it from whatever you owe (liabilities). It is commonly known as net worth (NW).read more. ShareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares.read more can transfer their stocks to another party, making the latter the next shareholder. In the company’s balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more, equity values can change. These additions or deductions are brought out by changes in realized profits, changes in unrealized profits, issuance of new shares, purchase of existing shares, and dividend declarationDividend DeclarationDividend declared is that portion of profits earned that the company’s board of directors decides to pay off as dividends to the shareholders of such company in return to the investment done by the shareholders through the purchase of the company’s securities.read more.

Investing in equity ownership is riskier than investing in other financial instrumentsFinancial InstrumentsFinancial instruments are certain contracts or documents that act as financial assets such as debentures and bonds, receivables, cash deposits, bank balances, swaps, cap, futures, shares, bills of exchange, forwards, FRA or forward rate agreement, etc. to one organization and as a liability to another organization and are solely taken into use for trading purposes.read more. Investors have no control over the workings of a company. Any loss encountered by the firm is directly reflected in the shareholders’ earnings.

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Equity Features

These shares hold the following characteristics:

Formula

The book value is computed as follows:

Equity Formula

Total assets include all current, fixed, tangible, and intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. read more represented on the company’s balance sheet. The liabilities comprise short-term debtsShort-term DebtsShort-term loans are defined as borrowings undertaken for a short period to meet immediate monetary requirements.read more, long-term debts, and other liabilities recorded on the balance sheet.

Examples of Equity

Let us assume that a company, ABC Ltd., is engaged in textiles manufacturing. Let us calculate the equity of ABC Ltd. on March 31, 2021. The Balance Sheet details are as follows:

Equity Example 1

Solution:

Calculating the book value of equityBook Value Of EquityThe book value of equity reflects the fund that belongs to the equity shareholders and is available for distribution to the shareholders. It is computed as the net amount remaining after deducting all of the company's liabilities from its total assets.read more:

Equity Example 1-1

Equity = Total Assets – Total Liabilities

            = $51,500,000 – $11,000,000

            = $40,500,000

Let us look at another example. According to Cisco’s quarterly balance sheet ending on October 30, 2021, we can see that the equity is computed as $42,701. 

Cisco’s quarterly balance sheet

Source: investor.cisco.com

Calculation:

Equity = Total Assets – Total Liabilities

            = 95,981 – 53,280

            = $42,701

Market Value

The Market CapitalizationMarket CapitalizationMarket capitalization is the market value of a company’s outstanding shares. It is computed as the product of the total number of outstanding shares and the price of each share.read more of publicly traded common stock can be construed as the company’s worth based on its market standing or its demand among investors.

The Market Capitalization formula is as follows:
Market Cap = No. of Equity Shares Outstanding × Current Market Price Per Share

Example:  A company has 250 million outstanding sharesOutstanding SharesOutstanding shares are the stocks available with the company's shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner's equity in the liability side of the company's balance sheet.read more, trading at $65 per share. In this case, the market capitalization can be calculated as follows:

Market Capitalization = 250,000,000 × 65

Market Capitalization = $ 16,25,00,00,000

The market valuation of any company is sensitive to multiple factors—the level of competition, economic condition, positive news, negative news, government regulations, and corporate performance.

Types

In business, there have been two different types of equity, as explained below:

Owner’s Equity Formula

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Equity (wallstreetmojo.com)

#1 – Owner’s Equity

The ownership value of a sole proprietary firm is evaluated after deducting the overall liabilities from the company’s total assetsTotal AssetsTotal Assets is the sum of a company's current and noncurrent assets. Total assets also equals to the sum of total liabilities and total shareholder funds. Total Assets = Liabilities + Shareholder Equityread more. It is a deciding factor in mergersMergersMerger refers to a strategic process whereby two or more companies mutually form a new single legal venture. For example, in 2015, ketchup maker H.J. Heinz Co and Kraft Foods Group Inc merged their business to become Kraft Heinz Company, a leading global food and beverage firm.read more and takeoversTakeoversA takeover is a transaction where the bidder company acquires the target company with or without the management's mutual agreement. Typically, a larger company expresses an interest to acquire a smaller company. Takeovers are frequent events in the current competitive business world disguised as friendly mergers.read more.

#2 – Stockholder’s Equity

When it comes to a public company, the shareholder’s equity represents the proportion of net assets received during liquidation.

Following are the various equity accounts:

  1. Common Stock: Common stocksCommon StocksCommon stocks are the number of shares of a company and are found in the balance sheet. It is calculated by subtracting retained earnings from total equity.read more gather the initial investment. Investors gain ownership of business assets. These stakeholdersStakeholdersA stakeholder in business refers to anyone, including a person, group, organization, government, or any other entity with a direct or indirect interest in its operations, actions, and outcomes.read more enjoy voting rights and superior control over the company’s management.
  2. Preference Stock: The preference stakeholders don’t get any voting rights in the company. They do, however, earn dividends and get paid before other shareholders.
Preference Shares

You are free to use this image on your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Equity (wallstreetmojo.com)

  1. Treasury Stock: Sometimes companies buy their shares back. These redeemed shares are termed treasury stocksTreasury StocksTreasury Stock is a stock repurchased by the issuance Company from its current shareholders that remains non-retired. Moreover, it is not considered while calculating the Company’s Earnings Per Share or dividends. read more.
  2. Additional Paid-in Capital: Any amount that the shareholders pay above the par value of the common or preferred stocks is the additional paid-in capitalAdditional Paid-in CapitalAdditional paid-in capital or capital surplus is the company's excess amount received over and above the par value of shares from the investors during an IPO. It is the profit a company gets when it issues the stock for the first time in the open market.read more—also known as contributed surplus.
  3. Retained Earnings: It is the reserve of profits maintained by businesses after paying dividends to the shareholders.

Importance

Issuing shares benefits both the investors and the firm. Let us see how:

For the Company

An organization’s net worthNet WorthThe company's net worth can be calculated using two methods: the first is to subtract total liabilities from total assets, and the second is to add the company's share capital (both equity and preference) as well as reserves and surplus.read more is made public in front of the world. Given below are some other benefits:

  • Business Capital: Dividing into small portions and issuing shares generates capital for the firm. This can be used to start or continue multiple projects.  
  • Market Capitalization: It determines a firm’s market capitalization.  
  • Builds Brand Image: When a company consistently holds a positive position, it indicates a healthy financial condition establishing its strong brand presence in the market.  
  • Leverage Free Financing: As the firm accumulates capital from the public by providing them partial ownership in the business, it no longer needs to rely on external debts.

For the Investors

Investors expect phenomenal returns on the investment. Following are some of the other advantages of purchasing shares:

Frequently Asked Questions (FAQs)

Are Stocks Equities?

Stocks are a type of equity financing. In the corporate world, equity represents ownership. Stocks are a bundle of small units. These small units of business ownership are offered to the investors. This way, firms raise capital.

How to Buy Equity?

Holding a portion of corporate ownership is a big deal. The easiest way to purchase equity is by investing money in the relevant company’s stocks.

What is the difference between equities and stocks?

Equity is the net worth of a company or its ownership stake, which may or may not be available for trade over the stock exchanges. There is always a book value and market value for the equity. A stock is a tiny portion of the firm’s equity or ownership available for public trading.

Recommended Articles

This has been a guide to What is Equity and its Meaning. Here we discuss equity formula, calculations, examples, stocks, and types. You can learn more from the following articles –