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What Is Equity?

Equity measures the value of ownership within a company. It can be used to measure ownership in a privately held company or a public company. Equity is measured by taking the total assets owned by a company and subtracting liabilities. Essentially, it is the monetary value of what is left after a company sells its assets and pays off its liabilities. 

How Does Equity Work?

Equity can also be applied to home mortgages. This is a good example to use to show how equity works. 

In this case, you would take the current value of a home and subtract that amount that is owed on the mortgage. This value is the amount of equity you have in your home. The same overall concept can be applied to large corporations. 

Why Is It Important?

Equity is important because it can show the value of a company. Also it can be used to fund expansion within businesses. It is one of the most commonly used pieces of data and can be used to show how financially healthy a company is. 

What Is Equity Apart of?

Stocks are an example of an equity-based instrument, which is a type of financial instrument that can be used to show ownership of an asset.

Stocks, otherwise known as equities, give shareholders the potential to earn profits from the shares they own. There are three other types of financial instruments, which include cash instruments, derivative instruments, and debt-based instruments. 

Where Can You Find Equity?

Equity is found on a company’s balance sheet. When looking at this, you’ll want to find the company’s total assets. You’ll also want to locate their liabilities. The equity is going to equal the company’s assets minus their liabilities

Is It Real Money?

Technically speaking, equity is not “real” money. It is more of a concept until it is sold. This is when it becomes real money; whether you are selling stocks or selling your property to pay off your mortgage.  

Example of Equity

There are several main examples of equity. Some that we have already discussed include common stock and preferred shares. Other examples include contributed surplus, retained earnings, and treasury stock. 

How Is Equity Calculated?

Equity is calculated on a company’s balance sheet. In order to calculate it, you need to locate a company’s assets and liabilities. Once you have found all of the information needed, you can calculate it using the following simplified formula: 

Equity = Assets – Liabilities 

What Ratios Use Equity?

A multitude of financial ratios use equity. One important ratio is return on equity (ROE). ROE is used to show investors the financial performance of the company they invested in. 

The higher the percentage of ROE, the better off a company is, financially speaking. It is calculated by dividing the net income of a company by the shareholders equity. 

ROE = Net Income / Average Total Equity

Other ratios that use equity include:

Working Capital Ratio: This is calculated by taking the total assets and dividing by the total liabilities. 

Working Capital Ratio = Total Assets / Total Liabilities 

Quick Ratio: Also referred to as the acid test, is calculated by subtracting a company’s current inventories from their current assets prior to dividing that number by their liabilities. 

Quick Ratio = (Current Inventory – Current Assets) / Liabilities 

Earnings Per Share (EPS): When you purchase a company’s stock, you are essentially paying into their future earnings. EPS is a way to measure the net income earned by a company’s common stock. 

Earnings Per Share = (Net Income –  Preferred Dividends) / Weighted Average of Shares Outstanding  

Price-Earnings (P/E) Ratio: This is also referred to as P/E and is used to reflect the future earnings based on investors’ assessments. 

Price-Earnings Ratio = Market Value Per Share / Earnings Per Share

Debt-To-Equity Ratio: This is calculated by taking a company’s long and short-term debt (or their liabilities), adding it together, and dividing it by the shareholder’s equity.

Debt-To-Equity Ratio = Total Liabilities / Shareholders Equity  

What Is Equity Financing?

Equity financing refers to the process in which a company sells shares to raise capital. Other examples include venture capital, angel investors and crowdfunding. Some companies will take on corporate investors, although this is usually done if a partnership between the two companies is to be expected. This type of financing can be a good choice for companies because it provides extra funding without any repayment obligations. 

What Can Equity Tell You About a Company?

It can help you determine the value of a company. It can be high or low, depending on how financially stable the company is when it is calculated. Let’s find out more about the differences.

High

High equity typically means that a person or company has more in assets and inventory than they do in debts to be paid. This is usually favorable for investors; however, most investors will not use this value alone as a standard to invest. It’s important to note that similar companies should be compared when looking at equity value.  

Low

Low equity means that person or company has more in liabilities or debts to be paid than they do in assets. This could be the result of excessive debt that was used to cover losses. If that is the case, it can represent higher risk for investors. Although, as mentioned above, investors will not use this value as the only standard to invest. 

Is Equity the Same as Assets?

It is not the same as assets. Assets are anything that a person or company owns that is expected to provide an economic benefit in the future. Assets are used to determine the equity of a company. Whether as, equity is the value represented by a company’s liabilities subtracted from their assets. 

Why Consulting a Financial Advisor Is Important

Equity is a measure of the financial position of an individual or company. It can be used to help guide investors. It shows that a company is able to cover their debts, or liabilities, with their assets. Consulting a financial advisor can not only help you to understand your personal equity, but it can also help you to understand equity within your investments.