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Business Financials – What is equity meaning in a business & accounting?
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Published on Thursday, 28 March 2024 14:30
Many business owners often inquire about the concept of equity.
Equity can be calculated by subtracting the liabilities from the assets of the business at their cost value, as reflected in the Balance Sheet financial statement.
This can be represented by the formula:
ASSETS – LIABILITIES = EQUITY.
Equity is sometimes referred to as Owner’s Equity for sole proprietors, or Shareholder/Stockholder Equity for companies with multiple directors.
In the context of a company's Balance Sheet, equity encompasses the money contributed by the owners, shareholders, or stockholders, in addition to the retained earnings (profit/loss from previous years). It depends on how the chart of accounts has been set out.
Owner’s Equity may also comprise of accounts such as Capital, Drawings, and Current Year Net Income/Earnings, while Shareholder Equity may include accounts like Paid-In Capital (including Preferred Stock, Common Stock, Paid-In Capital in Excess of Par Value, and Treasury Stock), Retained Earnings/Net Income, and Less Treasury Stock.
It is important to note that the market value of assets, such as plant and equipment, is not typically represented in the Balance Sheet unless adjustments are made to reflect changes in value, such as decline in value as the asset ages. These adjustments are balanced in a special depreciation asset account. Consequently, the company's market value may not accurately reflect the true market value unless such adjustments have been made.
Equity is also utilized in several key financial ratios that help assess the financial health of the business, including the Debt to Equity ratio and Return on Equity.
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