Equity Meaning: How It Works and How to

Calculate It
What you need to know about residual value
What Is Equity?
Equity, referred to as shareholders' equity (or owners' equity for privately held companies),
represents the amount of money that would be returned to a company's shareholders if all of the
assets were liquidated and all of the company's debt was paid off in the case of liquidation. In
the case of acquisition, it is the value of company sales minus any liabilities owed by the
company not transferred with the sale.

In addition, shareholder equity can represent the book value of a company. Equity can
sometimes be offered as payment-in-kind. It also represents the pro-rata ownership of a
company's shares. Equity can be found on a company's balance sheet and is one of the most
common pieces of data employed by analysts to assess a company's financial health.

KEY TAKEAWAYS

 Equity represents the value that would be returned to a company’s shareholders if all of
the assets were liquidated and all of the company's debts were paid off.
 We can also think of equity as a degree of residual ownership in a firm or asset after
subtracting all debts associated with that asset.
 Equity represents the shareholders’ stake in the company, identified on a company's
balance sheet.
 The calculation of equity is a company's total assets minus its total liabilities, and it's
used in several key financial ratios such as ROE.
 Home equity is the value of a homeowner's property (net of debt) and is another way the
term equity is used.

Equity

Investopedia / Katie Kerpel

How Shareholder Equity Works
By comparing concrete numbers reflecting everything the company owns and everything it
owes, the "assets-minus-liabilities" shareholder equity equation paints a clear picture of a
company's finances, easily interpreted by investors and analysts. Equity is used as capital raised
by a company, which is then used to purchase assets, invest in projects, and fund operations. A
firm typically can raise capital by issuing debt (in the form of a loan or via bonds) or equity (by
selling stock). Investors usually seek out equity investments as it provides a greater opportunity
to share in the profits and growth of a firm.

Equity is important because it represents the value of an investor's stake in a company,

represented by the proportion of its shares. Owning stock in a company gives shareholders the
potential for capital gains and dividends. Owning equity will also give shareholders the right to
vote on corporate actions and elections for the board of directors. These equity ownership
benefits promote shareholders' ongoing interest in the company.

Shareholder equity can be either negative or positive. If positive, the company has enough
assets to cover its liabilities. If negative, the company's liabilities exceed its assets; if prolonged,
this is considered balance sheet insolvency. Typically, investors view companies with negative
shareholder equity as risky or unsafe investments. Shareholder equity alone is not a definitive
indicator of a company's financial health; used in conjunction with other tools and metrics, the
investor can accurately analyze the health of an organization.

Formula and How to Calculate Shareholders' Equity

The following formula and calculation can be used to determine the equity of a firm, which is
derived from the accounting equation:

This information can be found on the balance sheet, where these four steps should be followed:

. Locate the company's total assets on the balance sheet for the period.
. Locate total liabilities, which should be listed separately on the balance sheet.
. Subtract total liabilities from total assets to arrive at shareholder equity.
. Note that total assets will equal the sum of liabilities and total equity.

Shareholder equity can also be expressed as a company's share capital and retained
earnings less the value of treasury shares. This method, however, is less common. Though both
methods yield the exact figure, the use of total assets and total liabilities is more illustrative of a
company's financial health.

What the Components of Shareholder Equity Are

Retained earnings are part of shareholder equity and are the percentage of net earnings that
were not paid to shareholders as dividends. Think of retained earnings as savings since it
represents a cumulative total of profits that have been saved and put aside or retained for future
use. Retained earnings grow larger over time as the company continues to reinvest a portion of
its income.
At some point, the amount of accumulated retained earnings can exceed the amount of equity
capital contributed by stockholders. Retained earnings are usually the largest component of
stockholders' equity for companies operating for many years.

Treasury shares or stock (not to be confused with U.S. Treasury bills) represent stock that the
company has bought back from existing shareholders. Companies may do a repurchase when
management cannot deploy all of the available equity capital in ways that might deliver the best
returns. Shares bought back by companies become treasury shares, and the dollar value is noted
in an account called treasury stock, a contra account to the accounts of investor capital and
retained earnings. Companies can reissue treasury shares back to stockholders when companies
need to raise money.

Many view stockholders' equity as representing a company's net assets—its net value, so to
speak, would be the amount shareholders would receive if the company liquidated all of its
assets and repaid all of its debts.

Example of Shareholder Equity

As part of its 2023 annual report, Apple reported $73.812 billion of shareholder equity. This
value was made up of common stock and additional paid-in capital. Of the 50.4 million shares
authorized, the company had issued roughly 15.5 million shares.

Apple also has several other types of shareholder equity activity. As of September 30, 2023 (the
date listed on the company's 2023 annual report), the company had an accumulated deficit of
$214 million. The company also reported an accumulated other comprehensive loss of $11.4
billion.

As part of Apple's 2023 report, the company listed $62.146 billion of shareholder equity. This
is up from $50.672 billion from on year prior.
Other Forms of Equity
The concept of equity has applications beyond just evaluating companies. We can more
generally think of equity as a degree of ownership in any asset after subtracting all debts
associated with that asset.

Below are several common variations on equity:

 A stock or any other security representing an ownership interest in a company.

 On a company's balance sheet, the amount of funds contributed by the owners or
shareholders plus the retained earnings (or losses). One may also call this stockholders'
equity or shareholders' equity.
 The value of securities in a margin account minus what the account holder borrowed
from the brokerage in margin trading.
 In real estate, the difference between the property's current fair market value and the
amount the owner still owes on the mortgage. It is the amount that the owner would
receive after selling a property and paying any liens. Also referred to as "real
property value."
 When a business goes bankrupt and has to liquidate, equity is the amount of money
remaining after the business repays its creditors. This is often called "ownership equity,"
also known as risk capital or "liable capital."

Private Equity
When an investment is publicly traded, the market value of equity is readily available by
looking at the company's share price and its market capitalization. For private entities, the
market mechanism does not exist, so other valuation forms must be done to estimate value.

Private equity generally refers to such an evaluation of companies that are not publicly traded.
The accounting equation still applies where stated equity on the balance sheet is what is left
over when subtracting liabilities from assets, arriving at an estimate of book value. Privately
held companies can then seek investors by selling off shares directly in private placements.
These private equity investors can include institutions like pension funds, university
endowments, insurance companies, or accredited individuals.

Private equity is often sold to funds and investors that specialize in direct investments in private
companies or that engage in leveraged buyouts (LBOs) of public companies. In an LBO
transaction, a company receives a loan from a private equity firm to fund the acquisition of a
division of another company. Cash flows or the assets of the company being acquired usually
secure the loan. Mezzanine debt is a private loan, usually provided by a commercial bank or a
mezzanine venture capital firm. Mezzanine transactions often involve a mix of debt and equity
in a subordinated loan or warrants, common stock, or preferred stock.

Private equity comes into play at different points along a company's life cycle. Typically, a
young company with no revenue or earnings can't afford to borrow, so it must get capital from
friends and family or individual "angel investors." Venture capitalists enter the picture when
the company has finally created its product or service and is ready to bring it to market. Some
of the largest, most successful corporations in the tech sector, like Google, Apple, Amazon, and
Meta—or what is referred to as GAFAM—began with venture capital funding.
Types of Private Equity Financing

Venture capitalists (VCs) provide most private equity financing in return for an early minority
stake. Sometimes, a venture capitalist will take a seat on the board of directors for its portfolio
companies, ensuring an active role in guiding the company. Venture capitalists look to hit big
early on and exit investments within five to seven years. An LBO is one of the most common
types of private equity financing and might occur as a company matures.

A final type of private equity is a Private Investment in a Public Company (PIPE). A PIPE is a
private investment firm's, a mutual fund's, or another qualified investors' purchase of stock in a
company at a discount to the current market value (CMV) per share to raise capital.

Unlike shareholder equity, private equity is not accessible to the average individual. Only
"accredited" investors, those with a net worth of at least $1 million, can take part in private
equity or venture capital partnerships. Such endeavors might require form 4, depending on their
scale. For investors who don't meet this marker, there is the option of private equity exchange-
traded funds (ETFs).

Home Equity
Home equity is roughly comparable to the value contained in homeownership. The amount of
equity one has in their residence represents how much of the home they own outright by
subtracting from the mortgage debt owed. Equity on a property or home stems from payments
made against a mortgage, including a down payment and increases in property value.

Home equity is often an individual’s greatest source of collateral, and the owner can use it to
get a home equity loan, which some call a second mortgage or a home equity line of credit
(HELOC). An equity takeout is taking money out of a property or borrowing money against it.

For example, let’s say Sam owns a home with a mortgage on it. The house has a current market
value of $175,000, and the mortgage owed totals $100,000. Sam has $75,000 worth of equity in
the home or $175,000 (asset total) - $100,000 (liability total).

Brand Equity
When determining an asset's equity, particularly for larger corporations, it is important to note
these assets may include both tangible assets, like property, and intangible assets, like the
company's reputation and brand identity. Through years of advertising and the development of
a customer base, a company's brand can come to have an inherent value. Some call this value
"brand equity," which measures the value of a brand relative to a generic or store-brand version
of a product.

For example, many soft-drink lovers will reach for a Coke before buying a store-brand cola
because they prefer the taste or are more familiar with the flavor. If a 2-liter bottle of store-
brand cola costs $1 and a 2-liter bottle of Coke costs $2, then Coca-Cola has brand equity of $1.

There is also such a thing as negative brand equity, which is when people will pay more for a
generic or store-brand product than they will for a particular brand name. Negative brand equity
is rare and can occur because of bad publicity, such as a product recall or a disaster.
Equity vs. Return on Equity
Return on equity (ROE) is a measure of financial performance calculated by dividing net
income by shareholder equity. Because shareholder equity is equal to a company’s assets minus
its debt, ROE could be considered the return on net assets. ROE is considered a measure of how
effectively management uses a company’s assets to create profits.

Equity, as we have seen, has various meanings but usually represents ownership in an asset or a
company, such as stockholders owning equity in a company. ROE is a financial metric that
measures how much profit is generated from a company’s shareholder equity.

Equity and Financial Accounting

The fundamental accounting equation is assets equalling the sum of liabilities and equity. This
equation is the basis for the balance sheet, which summarizes a company's financial position at
a specific point in time. In all of the examples we've discussed in this article, the basis of
calculating that equity was rooted in this accounting equation.

Liabilities are obligations that the company owes to external parties, such as loans, accounts
payable, and accrued expenses. Equity represents the residual claim on assets after satisfying
liabilities. A company can pay for something by either taking out debt (i.e. liabilities) or paying
for it with money they own (i.e. equity). Therefore, the equation reflects the principle that all of
a company's resources (assets) can be paid in one of those two ways.

What Is Equity in Finance?

Equity is an important concept in finance that has different specific meanings depending on the
context. Perhaps the most common type of equity is “shareholders’ equity," which is calculated
by taking a company’s total assets and subtracting its total liabilities.

Shareholders’ equity is, therefore, essentially the net worth of a corporation. If the company
were to liquidate, shareholders’ equity is the amount of money that would theoretically be
received by its shareholders.

What Are Some Other Terms Used to Describe Equity?

Other terms that are sometimes used to describe this concept include shareholders’ equity, book
value, and net asset value. Depending on the context, the precise meanings of these terms may
differ, but generally speaking, they refer to the value of an investment that would be left over
after paying off all of the liabilities associated with that investment. This term is also used in
real estate investing to refer to the difference between a property’s fair market value and the
outstanding value of its mortgage loan.

How Is Equity Used by Investors?

Equity is a very important concept for investors. For instance, in looking at a company, an
investor might use shareholders’ equity as a benchmark for determining whether a particular
purchase price is expensive. If that company has historically traded at a price to book value of
1.5, for instance, then an investor might think twice before paying more than that valuation
unless they feel the company’s prospects have fundamentally improved. On the other hand, an
investor might feel comfortable buying shares in a relatively weak business as long as the price
they pay is sufficiently low relative to its equity.

How Is Equity Calculated?

Equity is equal to total assets minus its total liabilities. These figures can all be found on a
company's balance sheet for a company. For a homeowner, equity would be the value of the
home less any outstanding mortgage debt or liens.

The Bottom Line

Financial equity represents the ownership interest in a company's assets after deducting
liabilities. It reflects the value that belongs to the shareholders or owners of the business.
Equity can also refer to other items like brand equity or other non-financial concepts.