What is equity? Definition and FAQs

Table of contents

• What is equity?
• How to calculate equity in business
• Why equity matters
• Equity vs owner's equity vs net worth
• How equity changes
• Where equity is recorded and how it's reported
• Track your business equity with confidence using Xero
• FAQs on business equity

Key takeaways

• Calculate your business equity regularly using the simple formula: total assets minus total liabilities equals equity, which shows your true ownership value and financial health.
• Monitor equity changes by tracking actions that increase it (making profits, paying down loans, collecting receivables) versus actions that decrease it (accumulating unpaid bills, taking on new debt, recording losses).
• Use your equity position strategically for business growth, as positive equity improves your ability to secure loans, attract investors, and negotiate better terms due to reduced risk profile.
• Track equity automatically through your balance sheet and financial statements, calculating it at least monthly for management decisions and quarterly for formal reporting requirements.

What is equity?

Equity is the money left after you sell your business assets and pay all your debts. It shows the true value of what you own.

Here's how equity works in practice:

• Your assets are worth more than your debts (positive equity)
• Your debts are more than your assets (negative equity)
• Your assets and debts are equal (zero equity)

Keeping positive equity helps your business stay financially healthy and legally compliant.

How to calculate equity in business

You can calculate equity with a simple formula: assets minus liabilities equals equity. This comes from the basic accounting equation: assets = liabilities + owner's equity.

To work out your business equity, follow these steps:

1. Add up all your assets, such as property, equipment, cash, and money customers owe you
2. Add up all your liabilities, like money you owe to suppliers, employees, lenders, and the tax office
3. Subtract your total liabilities from your total assets to find your business equity

Single asset example: If you own a truck worth $30,000 and still owe $12,000 on the loan, your equity in the truck is $18,000.

Why equity matters

Equity shows your business's financial health. It affects your options for growth, funding, and selling your business.

Here's why tracking equity is essential:

• Business sales: Equity determines your negotiating position and final payout
• Loan applications: Lenders use equity to assess your creditworthiness and collateral
• Investment decisions: Investors evaluate equity to understand their potential returns
• Insurance coverage: Insurers review equity when underwriting your business
• Legal compliance: Keeping positive equity helps you meet legal requirements and continue running your business.

Equity vs owner's equity vs net worth

Equity and owner's equity mean the same thing. In companies, it's often called shareholder equity, but shareholders are simply owners.

Owner's equity is also called net worth or capital. It shows how much money you would have left if you closed your business, sold all assets, and paid all debts.

How equity changes

Your business equity changes as your assets and liabilities change over time.

Actions that increase equity:

• Make a profit from your business operations
• Buy new equipment or facilities
• Pay down existing loans
• Collect money owed by customers

Actions that decrease equity:

• Accumulate unpaid bills
• Take on new debt
• Owe taxes or payroll
• Record business losses

If you take a loan to buy equipment, your equity usually stays the same at first. As you pay off the loan, your equity increases.

Where equity is recorded and how it's reported

You see owner's equity on your financial statements. You calculate it at the end of each accounting period.

Where to find equity:

• Find owner's equity at the bottom of your balance sheet, after assets and liabilities
• See changes in owner's equity in the statement of owner's equity
• Review owner's equity in your end-of-year financial statements

Reporting standards: These statements follow International Financial Reporting Standards (IFRS), which help keep reporting consistent worldwide.

Learn more in our guide on owner's equity.

You may also want to learn about these related terms:

• retained earnings
• balance sheet
• more accounting terms

Track your business equity with confidence using Xero

Understanding your business equity gives you the insights needed to make informed decisions about growth, funding, and your business's future.

With the right accounting software, tracking equity becomes automatic. Your balance sheet updates in real-time, showing you exactly where your business stands financially.

With Xero, you can track equity easily using automated calculations and real-time reports. You always know your business's true value and can make confident decisions about loans, investments, or growth.

Ready to take control of your business finances? Try Xero for free and see how easy equity tracking can be.

FAQs on business equity

Here are some common questions businesses have about equity.

What is the simple definition of equity?

Equity is the money left over if you sold your business and paid all debts. It represents the true value of your ownership stake.

What does negative equity mean for my business?

Negative equity means your business debts exceed your asset values. This typically indicates insolvency and may require you to cease operations legally.

How often should I calculate my business equity?

Calculate equity at least monthly for ongoing management and quarterly for formal reporting. This aligns with requirements from organizations like the Internal Revenue Service (IRS), which state that submitted financial information should generally be no older than six months.

Modern accounting software updates equity automatically with each transaction.

Is owner's equity the same as shareholder equity?

Yes, owner's equity and shareholder equity mean the same thing. Use 'shareholder equity' for corporations and 'owner's equity' for sole proprietorships and partnerships.

Can equity be used as collateral for loans?

Yes, you can use your business equity as collateral for loans. If you have higher equity, you may get better loan terms and lower interest rates because you are less risky to lenders.