What Is Equity in Accounting? It’s the Value Remaining After Liabilities
Equity is the remaining value of an owner’s interest in a company, after all liabilities have been deducted. You may hear of equity being referred to as “stockholders’ equity” (for corporations) or “owner’s equity” (for sole proprietorships). Equity can be calculated as:
Equity = Assets – Liabilities.
The word “equity” can also be used to refer to personal finances. For instance, if someone owns a $400,000 home, and has a $150,000 mortgage on it, then the owner can say he has “$250,000 in equity”, in the property.
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NOTE: FreshBooks Support team members are not certified income tax or accounting professionals and cannot provide advice in these areas, outside of supporting questions about FreshBooks. If you need income tax advice please contact an accountant in your area.
What Is Considered an Equity in Accounting?
Equity in a company may include tangible assets (assets in physical form) and intangible assets (assets you can’t actually touch, but are valuable). Here are some examples:
- Accounts Receivable
- Stocks & Bonds
- Brand recognition
- Customer lists
- Goodwill (representation of a purchased company’s total assets).
The assets of a company are offset by its liabilities. Common liabilities include:
- Accounts payable
- Unearned revenues
- Wages and salaries
What Is Equity on the Balance Sheet?
Equity is not considered an asset or a liability on a company’s financial statements. Equity is what you get when you subtract liabilities from assets.
Equity = Assets – Liabilities
Equity is reflected on a company’s balance sheet. Management can see its total equity figure listed at the bottom of this statement, next to “Total Liabilities and Stockholders’ Equity” or “Total Liabilities & Owner’s Equity”.
If the amount is negative, then the owner(s) or shareholders have no equity in the business, and the company is considered to be “in the red”.
What Is the Difference Between Stock and Equity?
Stock is a traded equity. You will often hear the words “stock” and “equity” used interchangeably, or referred to as “equity shares”.
How Does Equity Financing Work?
Equity financing is a method of raising capital for a business through investor(s). In exchange for money, the business gives up some of its ownership, typically a percentage of shares.
Equity financing can offer both rewards and risks for an investor and a business owner.
The investor is taking a risk, because the company does not pay back his investment. Rather, the investor is now entitled to more of the profits (because he now owns more of the company). This means an investor’s earnings may become significant as time goes on. However, if the company fails, then the investor can lose everything.
The business owner may now have the capital to realize his dreams. However, depending on the percentage of ownership given up, decisions regarding how the business is run may now have to now be shared. Relationships may become strained.
It is not uncommon for a startup to have several rounds of equity financing, in order to expand and meet its goals.