The Business Definition of Equity
As an individual, equity is the quality of being fair and impartial, which are terrific attributes of a small business owner. However, in finance a broad definition of equity is the value of an asset after deducting the value of liabilities. For a business, equity is the sum of earnings, inventory and other assets, less overhead, loans and other liabilities.
6 Forms of Equity
Here are the various forms of equity in business:
- An ownership interest in a company as represented by securities or stock. If this is in a company that is not publicly traded it is called private equity. Equity means the ownership interest of investors in a business firm. Investors can own equity shares in a firm in the form of common stock or preferred stock. Equity ownership in the firm means that the original business owner no longer owns 100% of the firm but shares ownership with others.
- On a company's balance sheet, equity is represented by the following accounts: common stock, preferred stock, paid-in capital, and retained earnings.
- If you are an investor in the stock market, equities are stocks, one of the principal asset classes in your portfolio.
- If you are an investor in the stock market and engage in margin trading, equity is the value of securities in a margin account minus what has been borrowed from the brokerage house.
- If you are talking about real estate, equity, or real property value is the difference between the fair market value of the property and what is still owed on the mortgage.
- If your business goes bankrupt and you have to liquidate, the amount of money remaining (if any) after the business repays its creditors is called “ownership equity”, or risk capital or liable capital.
Usage of each of these terms depends on context. All these forms of equity share the basic thread - the sum of earnings, inventory and other assets, less overhead, loans and other liabilities.
Positive and Negative Equity
Let's say that Joe wants to sell his business, Joe's Excellent Computer Repair. He doesn't own the building he's in, but he does have $10,000 worth of equipment and $5,000 in accounts receivable. Between his lease and loans, he owes $5,000. While this is an overly simplistic view, Joe has $10,000 of equity in his business.
Equity can also be negative. If Joe owed more than $15,000 his equity position would be in the red.
When calculating equity, and the value of assets, especially for larger companies, these assets may include both tangible and intangible assets. Tangible assets are things you can touch, like inventory or property. Intangible assets may include the company's reputation and brand identity or brand equity. This kind of equity is built up through years of being in business and servicing your customer base. It is most easily illustrated in the difference between a brand and a generic brand. When you are shopping, you may reach for a brand-name item because you know and trust it, and not select the generic brand even though it may cost less.
Small business owners have to put up some of their own money, or equity, in order to start their business and before seeking financing from other sources.