What is equity and how is it calculated?
October 25, 2022 3 min read
It’s likely that you’ve heard the word “equity” before. But what exactly does it mean, and how is it calculated?
Equity can mean different things. But in the world of business, it has to do with the difference after subtracting liabilities from assets. Read on to learn more about what equity is and how it’s calculated.
- Equity is the balance that remains after subtracting liabilities from all assets.
- In finance, equity is used to describe how much stake in ownership an entity has, whether it’s tangible or not.
- Equity can be positive or negative.
What is equity?
Equity is the difference between an investor’s or business’s assets and liabilities. It can be used to determine the profitability of a company or to determine an investor’s stake of ownership. Equity may also be referred to as net worth or capital.
It might help to think about it like this: Equity would be what’s left if a business or investor sold all their assets and paid off all debts. And equity can be positive or negative. For example, if an investor’s or business’s debts are more than their assets, they would have negative equity.
How to calculate equity
The formula for calculating equity is:
Equity = total assets − total liabilities
When calculating equity, it’s important to understand the difference between assets and liabilities.
- Assets: Things that an investor or company owns that have value. They may include cash, property, equipment, inventory, trademarks or patents. Essentially, to be considered an asset, it must be something that can be sold or used by an investor or company. This is also known as liquidity.
- Liabilities: Everything that an investor or company owes. They may include loans, rent on a building, payroll, taxes or other outstanding debts.
Other types of equity
While frequently used in business operations, equity is a term that pops up in other places too.
Home equity is the appraised value of a home, minus what’s still owed on the mortgage. As a homeowner makes payments toward the mortgage, the equity in the home builds.
Homeowners can borrow against the equity they’ve built through home equity loans or home equity lines of credit. They’re popular ways to finance home improvements or other financial needs.
A homeowner can also have negative equity in their home if they’re “underwater” on their mortgage. This happens when a homeowner owes more on their mortgage than the value of their home.
It’s important to note that not all equity is tangible. In the business world, for example, brand equity represents the positive or negative value that is linked to a brand, as well as the product or service that they provide.
There are multiple factors that can influence a brand’s equity. Those factors include consumers’ awareness of a brand, if consumers are loyal to that brand, the associations they have with the brand, and the quality of the brand’s products or services.
Private equity funds
With private equity, funds are managed by a private equity firm. All of the money that investors contribute to the fund is then distributed into a variety of investments that are made on behalf of the entire fund. These are generally long-term investments that can take upwards of 10 years to pay out.
Equity in a nutshell
Equity is a common financial term used in business operations, investing and more. All assets minus total liabilities equals total equity. This balance can be used to determine the profitability of a company or to determine an investor’s stake of ownership.
Learn more about the role equity plays in investments and mutual funds to understand the importance it can have on financial decisions.