Definition:

Equity is the portion of a company’s assets that are financed by shareholders’ equity capital. It is the residual interest in the assets of the company after deducting liabilities. Equity is also known as owner’s capital or common stock.

Formula:

Equity = Assets – Liabilities

Components of Equity:

• Common stock
• Retained earnings
• Other equity accounts

Importance of Equity:

• Sources of funds: Equity is a source of funds for companies to raise capital.
• Owners’ residual interest: Equity represents the residual interest of shareholders in the assets of the company.
• Shareholder wealth: Equity is a measure of shareholder wealth.
• Company valuation: Equity can be used to value a company.
• Debt-to-equity ratio: Equity is used to calculate the debt-to-equity ratio, which is an important measure of a company’s financial leverage.

Example:

A company has assets of $100,000 and liabilities of $50,000. Its equity is $50,000.

Key Points:

• Equity is the portion of a company’s assets that are financed by shareholders’ equity capital.
• Equity is also known as owner’s capital or common stock.
• The components of equity include common stock, retained earnings, and other equity accounts.
• Equity is a source of funds, a measure of shareholder wealth, and a component of company valuation.