Equity is the value of an asset once debt has been subtracted
What does equity mean?
Equity is the value of an asset once liabilities, such as debt, have been subtracted. A common term in finance, equity can also apply to other assets.
For example, let’s imagine that Imogen has a $20,000 car. She bought it using a loan, and still has $7,000 of repayments left to make. By subtracting the $7,000 debt from the $20,000 value of the vehicle, we can see that she has equity of $13,000.
In terms of property, it works a little differently. Let’s say William buys a $500,000 home with a $50,000 deposit, leaving him with a mortgage of $450,000. This would mean he has equity of $50,000. If the property suddenly soared in value and was now worth $800,000, he would have equity of $350,000.
Equity in finance
Now that we’ve covered examples of equity in everyday life, let’s delve into what it means in a financial setting.
This term normally refers to shareholder equity. Just as with cars and property, companies use this to illustrate the difference between their total assets and their total liabilities. A strong, positive figure indicates that the firm is in good financial health. As a result, this metric is often relied upon by analysts.
For shareholders, this figure illustrates how much they would receive if a corporation liquidated everything and paid off all its debts. It also helps investors deduce how risky a particular stock might be, and whether the business is stable.
Equity is important for investors because it can entitle them to dividends – a share of a company’s profits – on a regular basis. In other cases, they may receive voting rights, allowing them to have a say on the future direction of the business.
Negative shareholder equity suggests to an investor that a company amounts to a high-risk investment. This is because the liabilities (or debts) that the firm has racked up outweigh the total value of its assets.
For investors, shareholder equity is one of several metrics used when assessing a company or a business opportunity. Relying on this measurement alone does not always provide a full picture of an organisation’s financial affairs.