The term “equity” can be used in a number of different ways, from home value to investments. For accounting purposes, the concept of equity involves an owner’s stake in a company, after deducting all liabilities. Here’s a closer look at what counts as equity in accounting, and how it’s calculated.
What is equity in accounting?
There are two primary ways that equity is used in finance. The equity meaning in accounting refers to a company’s book value, which is the difference between liabilities and assets on the balance sheet. This is also called the owner’s equity, as it’s the value that an owner of a business has left over after liabilities are deducted.
The equity meaning in accounting could also refer to its market value. This is based on current share prices, or a value determined by the company’s investors. With this secondary meaning, it’s usually called shareholders’ equity or net worth. If all of the company’s assets are liquidated and debts paid off, the shareholders’ equity represents the amount of money remaining that would be distributed to the business shareholders.
Book value of equity in accounting
To calculate the book value of equity in accounting, you can use the following formula:
Equity = Assets - Liabilities
Accountants use this equity value as the basis for preparing balance sheets and other financial statements.
In this case the “asset value” includes all current and noncurrent assets, such as:
Machinery and equipment
To calculate the value of liabilities, you can add up all non-current and current liabilities on the balance sheet. These could include things like:
Fixed financial commitments
Accountants take all these pieces of the puzzle to track a company’s value. They must also include any share capital and retained earnings in the equation.
Market value of equity in accounting
Examples of equity in accounting will also look at market value. This meaning is the one used in finance, and it may display a different figure than the book value. This is because while accounting statements use historical data to determine book value, financial analysts use projections or performance forecasts to determine market value.
This figure is easy to calculate in the case of publicly traded companies. You can determine the market value of equity by multiplying the most recent share price by the total number of outstanding shares:
Equity Market Value = Share Price x Total Number of Outstanding Shares
In the case of privately owned companies, the calculation becomes more complicated. It might need to be formally valued by financial analysts, investment bankers or accounting firms. To calculate this equity value, professionals will use various methods like:
Comparable company analysis
Discounted cash flow analysis
In the case of discounted cash flow, for example, an analyst forecasts future cash flows before discounting these back to present value. To come to any conclusions using a complicated method like this, analysts look at all aspects of the business.
Personal equity in accounting
The meaning of equity in accounting could also refer to an individual’s personal equity, or net worth. As with a company, an individual can assess his or her own personal equity by subtracting the total value of liabilities from the total value of assets. Personal assets will include things like cash, investments, property, and vehicles. Personal liabilities tend to include things like lines of credit, existing debts, outstanding bills and mortgages.
Where is equity recorded?
For businesses, what counts as equity in accounting is recorded on the company’s balance sheet. This should be clearly displayed at the bottom of the statement, reflected as either “Stockholders’ Equity” or “Owner’s Equity” depending on ownership. Ideally, the equity figure will be positive. If it’s negative, this means that liabilities outweigh assets, and the business is “in the red” with outstanding debts. This is why it’s important to keep a close eye on equity, whether your business is publicly or privately owned.
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