What is Equity?

In finance and accounting, equity is the value attributable to the owners of a business. The book value of equity is calculated as the difference between assets and liabilities on the company’s balance sheet, while the market value of equity is based on the current share price (if public) or a value that is determined by investors or valuation professionals. The account may also be called shareholders/owners/stockholders equity or net worth.


There are generally two types of equity value:
1.    Book value
2.    Market value

Book value of equity
In accounting, equity is always listed at its book value. This is the value that accountants determine by preparing financial statements and the balance sheet equation that states: assets = liabilities + equity. The equation can be rearranged to: equity = assets – liabilities.


The value of a company’s assets is the sum of each current and non-current asset on the balance sheet. The main asset accounts include cash, accounts receivable, inventory, prepaid expenses, fixed assets, property plant and equipment (PP&E), goodwill, intellectual property, and intangible assets.


The value of liabilities is the sum of each current and non-current liability on the balance sheet. Common liability accounts include lines of credit, accounts payable, short-term debt, deferred revenue, long-term debt, capital leases, and any fixed financial commitment.


In reality, the value of equity is calculated in a much more detailed way and is a function of the following accounts:
•    Share capital
•    Contributed surplus
•    Retained earnings
•    Net income (loss)
•    Dividends


To fully calculate the value, accountants must track all capital the company has raised and repurchased (its share capital), as well as its retained earnings, which consist of cumulative net income minus cumulative dividends. The sum of share capital and retained earnings is equal to equity.


Market value of equity
In finance, equity is typically expressed as a market value, which may be materially higher or lower than the book value. The reason for this difference is that accounting statements are backward-looking (all results are from the past) while financial analysts look forward, to the future, to forecast what they believe financial performance will be.


If a company is publicly traded, the market value of its equity is easy to calculate. It’s simply the latest share price multiplied by the total number of shares outstanding.


If a company is private, then it’s much harder to determine its market value. If the company needs to be formally valued, it will often hire professionals such as investment bankers, accounting firms (valuations group), or boutique valuation firms to perform a thorough analysis.

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