What Is Equity in a Company? (With Definition and Types)
By Indeed Editorial Team
Updated August 11, 2022 | Published September 29, 2021
Updated August 11, 2022
Published September 29, 2021
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
In nearly every company, there are individuals and groups interested in its growth, development, and profitability. These individuals or groups own a portion of the company, called equity. By learning about equity in a company, you can understand what obligations a company has to individuals and groups who invest in the business. In this article, we answer, "What is equity in a company?" explain its importance, present components of shareholder's equity, discuss how to calculate this figure and provide an example, tips, and a list of other types of equity.
What is equity in a company?
Equity refers to the extent of ownership of a company or an asset. For example, suppose you have 10% equity as a shareholder in a manufacturing company. This means you own 10% of the manufacturing company. Shareholders are individuals or organizations interested in a company's profitability who own shares. Depending on where you work, your employer may also offer equity as an employee benefit. For example, you may receive 3% equity as compensation for improved work performance. While there are various types of equity, shareholders' equity is the most common.
Shareholders' equity is the balance after subtracting company liabilities from assets. Shareholders can legally expect to receive this amount after a company pays off debts. They can also expect to earn this net income if the business closes and distributes its assets or another company acquires it. Financial professionals include shareholders' equity in records, such as balance statements. It's an important figure that analysts use to assess a company's financial health. Shareholder's equity is a company's worth after deducting what it owes.
Why is shareholders' equity important?
Shareholders' equity is important because it represents what shareholders can expect to receive after significant company changes. While shareholders typically earn money from shares when a company grows or develops, equity describes income after settlements, liquidation, mergers, and acquisitions. If you're considering investing in a company, understanding this value can guide you on how to proceed with your investment. For example, suppose a company is experiencing consistent growth and owns more assets than liabilities. As a shareholder, the equity you can expect may encourage you to invest in the company by buying shares.
Owning shareholders' equity is also important because it lets shareholders express their opinions on business decisions. For example, owning equity may qualify you to participate in electing the company's board of directors.
What are the components of shareholders' equity?
Here are important components of shareholders' equity that analysts consider in calculations:
Outstanding shares refer to the number of company shares that all shareholders hold. These shareholders may include investors, company officers, and employees. On a company's records, financial professionals enter outstanding shares as capital stock. The government legally requires companies that make their shares publicly available to report outstanding shares.
Retained earnings, or retained surplus, refer to income a company earns and keeps instead of paying to shareholders. Many companies have retained earnings to use for future activities. For example, a company may use this amount to reinvest in the company. Retained earnings are typically the highest figure in shareholders' equity. You can find it on a company's balance sheet.
Treasury stock, or treasury shares, refers to the number of shares a company repurchases from investors after initially issuing them. They may decide to sell these shares later to raise capital or prevent company changes, such as takeovers. As a company keeps these shares, treasury stock reduces total shareholders' equity. It's a negative figure on a company's balance sheet.
Additional paid-in capital
Additional paid-in capital (APIC) refers to the money an investor pays above the original stock price. It is the difference between the original stock price and the price at which a company sells a stock. Only shareholders who buy shares directly from a company can have APIC. You can find the APIC on the equity section of a company's balance sheet.
How to calculate shareholders' equity
Follow these steps when calculating shareholders' equity:
1. Determine the company's total assets
First, find the monetary value of company assets. You typically need to collaborate with finance and accounting professionals and receive authorization to obtain this figure. Company assets include goods, such as offices, vehicles, computer systems, and furniture. It may also be intangible items, such as intellectual property or software.
2. Calculate the company's total liabilities
Next, find the company's liabilities, which refers to what a company owes. You also need permission from company executives to access this figure. Liabilities may be current or noncurrent. Current liabilities are short-term, and companies typically pay them within a year, such as employee wages and credit purchases. In comparison, noncurrent liabilities are long-term and typically paid after 12 months. They include deferred credit and retirement benefit plans.
3. Deduct the total liabilities from total assets
Finally, subtract liabilities from assets, this determines the net worth of the entire company. Here's an equation you can use to help you calculate the equity of a company:
Shareholder's equity = total assets - total liabilities
Example of how to calculate shareholders' equity
Review this example of how to determine shareholders' equity:
A marketing agency has cars, computer systems, buildings and furniture worth $750,000. An angel investor also provided $500,000 to the company as capital investment to ensure profitability. Every year, the marketing agency pays its employees $250,000. It also paid a fine of $300,000 to the government.
The company's assets are its cars, computer systems, buildings, furniture, and investment. Adding these figures gives $750,000 + $500,000, which results in $1,250,000.
The company's liabilities are the fine it paid and employee wages. Adding these figures gives you $250,000 + $300,000, which results in $550,000.
The shareholder's equity is the difference between company assets and liabilities. Subtracting both figures gives $1,250,000 - $550,000, which results in $700,000.
Company executives legally need to use the shareholders' equity of $700,000 to pay all shareholders if it merges with another marketing agency. Similarly, a company legally must pay this amount to investors if the company liquidates.
Tips for calculating shareholders' equity
If you're responsible for calculating shareholders' equity in a company, here are the best practices to ensure accuracy:
Use a calculator
Calculating shareholders' equity typically involves large numbers. You may also have decimals in values you obtain for a company's assets and liabilities. For example, total employee wages may have decimals. With a calculator, you can perform these calculations easier and more efficiently. Consider using an online equity calculator, which typically requires entering the values for each asset and liability.
Write out the figures and formula
Having the assets and liabilities written out on paper or a spreadsheet helps you quickly reference the information you need. You may also want to write the equation to ensure you use the correct shareholder equity formula. Determine the company's total or assets completely before proceeding to determine the shareholders' equity.
Check your calculations
Review your calculation to ensure you used the correct values. For example, if you get a negative value for shareholders' equity, confirm that you didn't deduct the assets from the liabilities. You also want to verify that you accounted for each asset or liability only once in your calculation.
Other types of equity
Aside from shareholders' equity, here are other common equity types:
Private equity is the balance after deducting liabilities from assets in privately traded companies. A private company has owners who may issue shares to selected shareholders but not the general public. For example, many management consulting firms are private companies. The equation for shareholders' equity also applies to private equity.
Owner's equity refers to the proportion of a company and its assets that owners can claim after accounting for liabilities. Depending on the type of company, these owners may be sole proprietors, partners or corporations. A sole proprietorship has one owner, and a partnership has two owners. Corporations can have multiple owners. Financial analysts also use the shareholder equity equation to determine the owner's equity.
Home equity is the interest value you have in your home. It refers to the part of a home's current value that you own. You typically acquire equity in a home when purchasing it and receive more equity through mortgage payments. For example, suppose you bought a house using a mortgage loan. The institution that provided the loan holds a percentage of the home's value until you pay the loan completely.
This article is for informational purposes only and does not constitute financial advice. Consult with a licenced financial professional for any issues you may be experiencing.
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