- Equity is basically the difference between the value of all assets owned and the cost of any associated liabilities. Within the context of accounting, while the term equity is applied in numerous ways it generally refers to an ownership interest in a business. Thus equity represents what the business owes to its owners which is a reflection of the capital remaining in a business after all the assets of the entity are used to pay off the liabilities of the business.
Equity = Assets – Liabilities
Equity is of great significance to a business owner as it represents that portion of the total assets of the company that the owner owns which may also be referred to as net worth. For example, if an owner purchased cafe worth $500,000 with a $400,000 loan and $100,000 in cash then the owner has acquired an asset of $500,000 but only has $100,000 of equity.
Throughout the existence of a business, the equity of that business will be the difference between its assets and liabilities.
Equity will increase as the value of assets increase. These increase may be derived from such items a the value of the property owned, income streams, shares, client base plus any other asset that can increase in value.
In a balance sheet equity will generally comprise two components being (1) capital received from the sale of company shares or (2) retained earnings which are profits not distributed to owners or shareholders
Please note: Prepared by Leigh Barker Accountant at MWC Group, Tangible Assets, Portfolio Finance, Gordon and West Pennant Hills. Note that all content of this blog is general in nature and anyone intending to apply the information to practical circumstances should seek professional advice to independently verify their interpretation and the information’s applicability to their particular circumstance.