- Shareholder’s equity refers to the value of the company’s stocks once all of its assets have been liquidated
- Market value of equity is the public value of the entity’s shares on the stock market
- Shareholder’s equity helps to determine the value of a company, the involvement from investors, and can be used to grow the business and take out loans
- Outstanding shares are the stocks that have been sold to investors
- Additional paid in capital refers to what has been paid for the shares on top of their market value
- Retained earnings refer to the income not paid out to shareholders, and treasury stock is the accumulation of repurchases shares
- Private, home, and brand equity all refer to types of equity that add value to companies or individuals
- Return on equity measures a company’s ability to generate profit based on its equity
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What is equity?
Equity is also referred to as shareholders’ equity if the company’s stocks are public, or owners’ equity for privately held companies (i.e. one or few shareholders). In the event of asset liquidation, equity refers to the amount of money that would be returned to shareholders. For this to happen, the company must also have paid off all outstanding debts.
Book value of equity
Book value is the remaining value of the company once all assets have been liquidated, and is what shareholders stand to receive.
And financial assets:
- Short-term investments
- Accounts receivable
Market value of equity
Market value refers to a company’s value according to the stock market. While book market value is an estimation of the value of assets, market value communicates the current stock market value of those assets, if the company were to liquidate its assets at that moment. Market value is also referred to as market capitalisation.
When a company’s shareholder equity is calculated, it gives potential investors the clearest picture of a company’s financial health. The ‘assets minus liabilities’ equation can be easily interpreted by both analysts and interested investors, as to the current state and worth of the company.
- Attending boardroom meetings
- Vote on corporate decisions
- Make decisions on future investments
- Bring in other potential shareholders
Shareholder equity can be both negative and positive:
- Negative shareholder equity: company’s liabilities exceed its assets
- Positive shareholder equity: company’s assets exceed liabilities
Investors view companies with negative equity as more of a risk to invest in, because the company may never reach a point where its assets exceed its liabilities. However, shareholder equity is not the only measure of a company’s financial health and will not eliminate the possibility of any investment in the company.
How to calculate equity
There are a few different equations which can be used to calculate a company’s equity in totality.
Total assets – total liability = shareholder’s equity
The market value of a company depends on the value of its shares and is calculated like this:
Current market price per share x number of outstanding shares
Free download: equity calculation template
In case you need a bit of help to calculate your company’s own equity, you can just download our calculation template for free. Just add your individual numbers in the cells highlighted in green. The correct calculation results will then appear in the orange cells automatically.
To further clarify the above equations, components of shareholder equity must be broken down. This makes assessing the value of total shares much more accurate.
Outstanding shares are the shares that have been sold by the company to investors and not repurchased by the company. They are outstanding because they are no longer in sole possession of the company owners.
Additional paid-in capital
This represents the amount paid for the shares at face value (commonly referred to as ‘par value’). Additional paid-in capital or APIC is derived from the difference between the value of the stock and what has been paid for it.
Created when a company retains income instead of paying it out to stockholders, retained earnings can create a positive balance in the company’s account. The company may then use them to pay off debts or reinvest in the business.
The final component in shareholder’s equity, treasury stock, refers to the number of shares sold to investors which have then been repurchased by the company. Treasury stock can be used to raise capital or prevent a hostile takeover, in which the company is forcefully acquired by another.
Which other types of equity are there?
Certain types of equity determine the value of a certain asset or investment from a company or individual. Below are definitions of the three major types of equity.
Private equity is not listed on a public exchange. It comprises capital not listed on a public exchange, therefore it is not accessible to the public. Made up of funds and investors directly investing in companies or engaging in company buyouts, private equity can be used to fund equipment or new technologies, fund acquisitions, or simply improve a balance sheet.
A form of home ownership, home equity is essentially how much of a residence that an individual owns. It is determined by subtracting from the mortgage debt owed, because equity is accumulated with each payment made on the residence’s mortgage. The bigger the payments made, the larger the home equity., i.e. the more ownership the individual has over the home.
An intangible asset of a person or company, brand equity differs from the value of its physical assets, i.e. property, resources, or staff. Brand equity measures the value of the company’s name and reputation, especially when compared with competing generic brands.
The difference between equity and return on equity
Where equity determines the value of shares after a company has liquidated its assets, Return on Equity or ROE is a measure of a company’s profitability and efficiency in generating profits. It measures how effective the company is at generating profits based on its equity.
Net income / Average shareholder’s equity = Return on equity]
Investors will usually look to invest in a company whose ROE is close to the average ROE in that company’s industry. If the industry average ROE is 15%, and Company X has steadily maintained an 18% ROE, then the investor can assume Company X has maintained above average management and profits over a long period of time.