As accountants, we’re well-versed in industry jargon, but for business owners, it can sometimes feel like learning a whole new language. That’s why we created this series to help make accounting terms more accessible. In this article, we break down what equity means for businesses.
What is Business Equity?
In simple terms, if you own a business, equity is the net worth of that business. To calculate equity, you need to know the value of your business’ assets and liabilities.
Assets
Assets are things that the business owns which have a value. These can include:
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- Buildings, furniture, and land
- Cash
- Equipment and supplies
- Accounts receivable (payments owed to you by customers)
- Copyrights, patents, and trademarks
- Branding
Liabilities
Liabilities are amounts the business owes or needs to pay in the future. These might include:
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- Accounts payable (payments owed to suppliers)
- Salaries and wages
- Tax
- Loans
How Equity Fits In
Equity is calculated by subtracting liabilities from assets. The formula is:
Equity = Assets – Liabilities
The equity of a business represents “what’s left over” once liabilities are deducted from assets. In other words, it’s the value of the business on paper.
However, it’s important to remember that the equity on the balance sheet doesn’t reflect all of a business’s value. There may be other factors that add significant value, such as potential growth, market opportunities, or the value of the customer base that the business generates.
What Does Equity Mean for Small Businesses?
For small businesses, equity is essentially the valuable portion of the business that remains after subtracting liabilities from assets. The more equity a business has, the more valuable it is.
Businesses can sometimes use this equity as leverage to raise investment.
Selling Equity to Raise Funds
When you own shares in a business, you own equity and a share of the profits. If the business performs well, its profits grow, and the value of the equity increases.
A limited company might choose to sell equity (in the form of shares) in order to raise funds for growth.
What’s in It for the Investor?
An investor purchases shares in exchange for equity with the hope that the value of those shares will grow over time. There are two main ways an investor can benefit from owning equity:
- Receiving Dividend Payments
Shareholders receive a proportion of the profits, paid as dividends. The amount depends on how much of the business they own. There is also a yearly tax-free Dividend Allowance, which lets shareholders receive up to £2,000 of dividend payments each year without paying tax. - Selling Shares at a Later Date
If the company becomes more valuable over time, the equity owned by shareholders increases in value as well. Shareholders can sell their shares for more than they originally paid, resulting in a profit (also known as a capital gain).
