What Is Business Equity and How to Calculate It?
Companies use their business equity to fund their growth and expansion. To source these funds, owners sell a part of the company to various investors which represents equity. Read on to know what equity means in business, its types and how to calculate it.
What Is Business Equity?
In simple terms, you can calculate business equity as the difference between the total assets and total liabilities of the company. One can get an idea about the valuation of a company by looking at the equity.
Equity value is recorded in the company's balance sheet. A quick glance at the equity value can give prospective and current investors a general view of a company's financial health. If the company has a negative equity value, i.e., total liabilities exceed total assets, it indicates balance sheet bankruptcy or insolvency.
Now, as you are familiar with the definition of business equity, it’s time to move to types of equity and other aspects.
What Are the Types of Business Equities?
There are primarily two types of equities in a company which are as follows:
1. Stockholder Equity
A stockholder’s equity is the total ownership of various investors of the company in the form of shares or stocks. It shows the amount that is required to be paid to the stockholders at the time of liquidation.
A stockholder’s equity includes retained earnings apart from regular dividends. Retained earnings refer to the part of profit which a company saves rather than distributing it. A stockholder’s equity is more common in case of corporations.
2. Owner’s Equity
An owner's equity refers to the amount invested by the owner of the company. It is applicable in case of sole proprietorships or partnerships, in which there is a limited number of owners who have absolute control over the business.
This equity shows the capital available in a sole proprietorship/partnership. One can also use them to measure a company's worth.
How to Calculate Business Equity?
Here is the formula for calculating business equity:
Business Equity = Value of Total Assets – Value of Total Liabilities
You can find information about a company’s assets as well as liabilities on the balance sheet of the company.
As per the formula mentioned above, business equity can be calculated in the following way:
Value of Total Assets (A)
Value of Total Liabilities (B)
Business/Shareholders’ Equity (A-B)
What Are the Things to Consider Before Offering Business Equity to Investors?
Here are some things that businesses should consider before getting financing against business equity:
1. Amount of Funds Needed
Before issuing its equity to new investors, a company should take their fund requirements into consideration. The size of the fund requirement will help a company decide the quantum of shares that need to be issued. It will also decide whether a company should target institutional investors or retail investors.
2. Current Business Structure
The existing business structure of the company is another factor that companies should take into account while issuing shares to the public. The promoter or directors may have to dilute their equity and issue new shares to get funding from investors.
3. Access to Equity Markets
The accessibility of equity markets is another important factor when giving up equity. Large companies can offer equity to the public in huge amounts to receive considerable investment for expansion. However, small companies may not meet the minimum requirements to enter equity markets.
4. Long-term goals
A company may consider their long-term goals before giving up equity to new investors. Issuing equity shares can be a viable alternative if the long-term objective of the company is to go public or list their shares on stock exchanges.
Potential investors always keep an eye on the equity value of a company while deciding whether to go for an investment or not. This detailed guide about the meaning of business equity, its calculation and types will provide meaningful insights to investors about the nitty gritty of business equities