Equity represents the accounting (book) value of a company or it can represent ownership of a specific asset, such as a car or house. Learn more about equity in finance and how investors use it to make business decisions.
Equity Meaning in Finance
In finance, equity means ownership of assets. With respect to businesses, stockholders equity (or owners equity) is the value of assets a company has remaining after eliminating its liabilities. For an investor, stock and equity are synonymous terms because stocks represent equity ownership in a company. Assets, liabilities, and shareholders' equity are items found on the balance sheet.
Equity Example
Equity can be calculated by subtracting liabilities from assets and can be applied to a single asset, such as real estate property, or to a business. For example, if someone owns a house worth $400,000 and owes $300,000 on the mortgage, that means the owner has $100,000 in equity.
To calculate shareholders' equity of a business:
Shareholders' Equity = Assets - Liabilities
For example, if a company's total book value of assets amount to $1,000,000 and total liabilities are $300,000 the shareholders' equity would be $700,000.
Book Value: Definition & Formula
Book value, for a corporation, is usually updated quarterly, and reflects total assets less total liabilities. Book value is the amount of money that shareholders would receive, in aggregate, if a company's assets were to be liquidated and all its liabilities paid IF all assets and liabilities were settled at their carrying value on the balance sheet. Assets that contribute to a company's book value include real estate, machinery, equipment, inventory, and even cash. Liabilities can include bank loans, accounts payable, pension obligations, and taxes.
Market Value: Definition & Formula
Also known as market capitalization, equity market value is a company's current stock price multiplied by the number of outstanding shares. The market value of equity is usually different than the book value of equity, because stock prices move based on investors' outlooks for the company, and not necessarily real tangible results reflected on the company's balance sheet.
The formula for market value is:
Market Value = Price per Share X Number of Shares Outstanding
Book Value versus Market Value
When valuing a company, investors may compare a company's book value to its market value, to help assess how fairly the stock is priced.
The formula for Price-to-book-value is:
P/B = Market Price per Share / Book Value per Share
Consider a brand new company that is financed with $8 million in equity, and $2 million in debt. This company's book value would stand at $8 million. If the company earned accounting net profits of $500,000, the book value would increase to $8,500,000.
If investors felt that more profits were on the way, they might assign a market value that exceeds the book value. If, for example, investors assigned a market value of $10,625,000 million to the company, the Price/Book ratio for this company would become 1.25x ($10,625,000 / $8,500,000).
Bottom Line
For an investor, stock is synonymous with equity, which represents ownership. For a business, shareholders' equity is a major item on the balance sheet and represents the difference between the total value of assets and total liabilities. Market value of equity may be substantially different than the value of the shareholders' equity account on the balance sheet.
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