What Does Equity Mean? (Definition and How It Works)

By Indeed Editorial Team

Updated October 5, 2022 | Published February 4, 2020

Updated October 5, 2022

Published February 4, 2020

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.

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Equity is the value and ownership an organization or individual has in a business or personal asset after subtracting its liabilities. Equity may include goods, stocks and property in equity, so this amount can vary significantly. Understanding what it is and the different types of equity, such as stockholder's equity, home equity and private equity, can help professionals and businesses understand their financial health.

In this article, we define what equity is, including how to calculate it, review why it's important and explain stockholder equity and other common types.

What is equity?

Equity is the money that stockholders receive after a company liquidates its assets and pays off its debts. This means equity equals the value and ownership an individual or business has in an organization, after subtracting liabilities, such as debt.

Financial analysts define equities as standard metrics to assess if a business is doing well financially. Understanding the basics of equities can benefit businesses and professionals, allowing them to gain a better understanding of their investments, and make informed business decisions in the future.

Related: Learn About Being a Financial Analyst

How to calculate equity

To calculate equity, you can add up the company's total assets and subtract its total liabilities from this amount. Here's a formula you can use to calculate equity:

Company's total assets - Company's total liabilities = Stockholder's equity

After calculating the stockholder equity, you can determine also calculate the company's total assets using this formula:

Company's total assets = Stockholder's equity + Company's total liabilities

Calculating a company's equity is a crucial step for stockholders, as it helps them to determine if a company is financially stable. Depending on its stability, they can decide if they want to invest in it.

Related: Top 10 Accounting Interview Questions

Why is equity important?

Equity is important for investors because it represents the financial stake they have in the company. If the company does well, the stockholders may reap profits from the shares they own. They may get capital gains and dividends, and the share price might appreciate.

Aside from financial benefits, the ownership of a company's shares also gives the stockholder the right to cast their vote when the company holds elections to select members for its board of directors. That gives them a certain amount of decision-making power in the company, and that can play a very significant role in how the company fares in the future.

Related: Decision-Making Methods for the Workplace

What is stockholder's equity?

Since equity is a representation of the financial stake that stockholders have in a company, equity is also called stockholder equity or shareholder equity. While there are other types, stockholder equity is common because it includes all types of equity that involve individuals and companies making financial contributions and investments in an organization. You can use the equity formula to calculate a company's or professional's stockholder's equity.

Related: What Is Stockholder's Equity? Definition and Formula

What is included in stockholder's equity?

In a company's balance sheet, stockholder equity provides valuable insights regarding a company's financial health by including its total assets and total liabilities in two separate columns. Using this financial statement, you can see what the company owns and what it owes and compare the exact numbers.

It's also possible to calculate stockholder equity by adding a company's share capital with its retained earnings and then subtracting the treasury shares value from this amount. Depending on the numbers, you may calculate a positive or negative stockholder equity. If the company's assets exceed its liabilities, you get positive stockholder equity. This means that the company has the financial ability to cover its debts.

If these are more than its total assets, you calculate negative stockholder equity. This may not be good for the company, so potential investors may use it together with other metrics to evaluate the company's financial health and decide whether to make an investment.

Related: How To Create a Balance Sheet: Required Sections and Format

Items in stockholder equity

Here is a more in-depth look at stockholder equity includes:

Retained earnings

Stockholder equity includes retained earnings. These represent a portion of the company's earned income that it sets aside and doesn't use to pay the stockholder dividends. The company saves the retained earnings for future use, or it may reinvest them in the company. As a result, the total amount of the company's retained earnings may continue to grow, and it can even eventually surpass the amount of stockholder equity invested in the company.

Related: What Is the Retained Earnings Formula?

Treasury shares

Sometimes the company's equity is not enough for their purposes. In that case, they may buy back some of their shares from the stockholders. These bought-back shares are treasury shares, and they're in an account called a treasury stock. There are separate accounts of retained earnings and investor capital as well. If the company wants to raise money for business growth at a later point, it may decide to reissue these bought-back shares to the stockholders again.

Related: What Is Treasury Stock? Definition, Records and Examples

Uses of stockholder's equity

The financial sum that stockholders invest in a company provides it with the growth capital it needs to operate its business and fund further expansion. To get the initial business investment from stockholders, a company typically issues its shares in the stock market. If the company is new, it can use the resulting funds to start its business. If it's an established company, it may use the funds to further its business interests with additional acquisitions or by paying off existing debts.

Other types of equity

Here are some other types of equity you may encounter:

Private equity

Private equity refers to the assets and debts of privately traded companies that don't use public exchanges to get funding. This means they're not available for public trade. You can use the same accounting equation here as for stockholder equity. Investing in a private equity business partnership requires you to have at least $1 million to contribute.

Related: What Is Private Equity? (Plus FAQ About Private Equity)

Equity funds

Also called "hedge funds" or "mutual funds," equity funds allow you to make low-risk, for-profit investments in diverse companies. You can choose to invest in equity funds on your own. You can also invest in a mutual fund that invests in equity funds for you.

Business equity

To calculate the business equity of a company, you must add up the assets it has, such as goods, equipment and earnings. Then, add up the loans and other liabilities the company has. Subtract these liabilities from the assets, and you get the business equity.

Related: What Is a Statement of Equity?

Small-cap and large-cap equity

The equities for small and large companies, respectively, are known as small-cap and large-cap equities. For small-cap equity, a company must have shares valued between $300 million and $2 billion, while the share valuation for large-cap equity is between $5 billion and $10 billion. Generally, small-cap equities are not traded publicly.

Home equity

Home equity is the interest in the property that the homeowner owns. You can calculate the home equity value by taking its current market price and subtracting any outstanding loans or mortgages from that. So, if you have a house with a market price of $400,000 and have loans or mortgages totaling $300,000, your home equity is $100,000.

Related: Owning Equity: Definition and Examples

Equity capital

Businesses that seek funds to run their operations may sell ownership rights in their company to raise the necessary capital. The funds from investments collected by selling ownership rights is equity capital. Investors don't receive their initial equity capital back, but they may make a profit if the company flourishes.

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