What Is Equity? Definition, How to Calculate It & How to Manage It With Software

What is equity?

In accounting, equity represents the ownership value of a business after all its debts have been paid.

Essentially, equity is the portion of the company that belongs to the owners or shareholders.

A simple way to think about it is:

Equity = Assets – Liabilities

What the business owns minus what it owes.

Equity can include things like the owner’s initial investment, additional contributions, retained profits the business has earned over time, and adjustments like shares issued or dividends paid.

Equity tells you how much of the business truly belongs to the owners once all obligations are met.

For example, imagine you run a small coffee cart.

You own the cart, the coffee machine, and all your supplies, but you also took out a small loan to help buy the cart.

If you decided to sell your coffee cart business today, you would use the money from the sale to pay off the remaining loan.

Whatever amount is left after paying that debt is your equity, the real value that belongs to you as the owner.

How does equity work?

The shareholder equity formula (assets minus liabilities) gives investors and analysts a straightforward representation of a company's financial position by showing exactly what it owns versus what it owes.

Companies use equity as a funding source to buy assets, launch projects, and run their business. They can raise money either through debt (loans or bonds) or by selling equity (stock).

Investors typically prefer equity investments because they offer better chances to benefit from the company's profits and expansion.

Equity matters because it shows how much of the company an investor actually owns through their shares.

Stock ownership can generate returns through rising share prices and dividend payments. It also gives shareholders voting rights on major company decisions, which keeps them engaged in the company's direction.

Shareholder equity can be positive or negative.

Positive equity means the company's assets exceed its debts, and negative equity means debts outweigh assets, which, if it continues, signals balance sheet insolvency.

Investors generally see negative equity as a warning sign, however, equity alone doesn't tell the whole story, it works best when combined with other financial measures to assess a company's true financial condition.