Definition of equity
Equity is the total amount that the company owes its owners (or, if it is a legal entity, its shareholders). It is also known as the book value of a company. In essence, an organization owes its owners the initial amount of investment and the subsequent profits and losses that the business makes from its inception. If owners have withdrawn an amount from the business, that amount will also be adjusted accordingly. This investment, as well as the profits and losses, are represented by the company's assets and liabilities. Therefore, the owners' equity ultimately represents the organization's capital that is theoretically available within the company to be distributed to its shareholders.
How to calculate equity on a balance sheet
Calculation of the equity of the owners on the balance sheet of a sole proprietorship
Equity represents the value that the owner can catch up after selling his assets and paying all debts. This can be calculated by adding the following values.
Equity = initial investment by the owner + donated capital (if any) + subsequent profits - subsequent losses - withdrawals by the owner
Calculation of the equity of shareholders on the balance sheet of a registered company
Equity represents the value that remains in the company after all assets have been liquidated and all debts have been settled. This residual value is the amount that will be distributed to the company's shareholders. This can be calculated by adding up the balances of all equity accounts appearing on the balance sheet (ex-common stock account, preferred stock account, retained earnings, etc.). This can be represented simply as follows.
Calculating the equity of owners on a balance sheet using the accounting equation
This is an alternative approach to calculating the equity of owners and shareholders using the values that appear on the balance sheet. This approach uses the primary accounting equation to calculate the equity of owners or shareholders. This is a simple approach and can easily be applied to calculate the equity of both sole proprietorships and shareholders of a company.
The accounting equation is
Assets = liabilities + management equity
The formula for calculating the equity can be easily derived from this:
Equity = assets - liabilities
The process of calculating equity on a balance sheet
There are three steps to this process.
Step 01 : Calculate the value of the total assets, both tangible and intangible. These assets are calculated on the basis of the current market value, not on the basis of the acquisition costs, with an allowance or depreciation.
Step 02 : Calculate the value of total debt, both short-term and long-term debt.
Step 03 : Subtract the value of total liabilities from the value of total assets. The answer can be positive or negative. If the value is positive, this is the amount that the owners or shareholders are due. If the value is negative, this is the amount the owner owes the organization, in the case of a sole proprietorship, and if it is a legal entity that is obligated on behalf of the company itself.