What is Business Equity?
As accountants, we’re well-versed in industry jargon, but for business owners, it can sometimes feel like learning a whole new language. That’s why we created this series to help make accounting terms more accessible. In this article, we break down what equity means for businesses.
What is Business Equity?
In simple terms, if you own a business, equity is the net worth of that business. To calculate equity, you need to know the value of your business’ assets and liabilities.
Assets
Assets are things that the business owns which have a value. These can include:
- Buildings, furniture, and land
- Cash
- Equipment and supplies
- Accounts receivable (payments owed to you by customers)
- Copyrights, patents, and trademarks
- Branding
Liabilities
Liabilities are amounts the business owes or needs to pay in the future. These might include:
- Accounts payable (payments owed to suppliers)
- Salaries and wages
- Tax
- Loans
How Equity Fits In
Equity is calculated by subtracting liabilities from assets. The formula is:
Equity = Assets – Liabilities
The equity of a business represents “what’s left over” once liabilities are deducted from assets. In other words, it’s the value of the business on paper. On a balance sheet, this figure is usually shown as owner’s equity (for sole traders and partnerships) or shareholders’ equity (for limited companies), and it typically includes share capital, retained earnings, and any reserves built up over time.
However, it’s important to remember that the equity on the balance sheet doesn’t reflect all of a business’s value. There may be other factors that add significant value, such as potential growth, market opportunities, or the value of the customer base that the business generates.
Can Equity Be Negative?
Yes. If a business’s liabilities are greater than its assets, it has negative equity, sometimes called a capital deficiency. This doesn’t automatically mean a business is failing, but it’s a signal worth investigating. Common causes include sustained trading losses, taking on debt to fund growth before that growth has paid off, or a director’s loan account that’s gone overdrawn. A business with negative equity can still operate normally, but it may find it harder to secure lending or attract investors until the position is corrected.
What Does Equity Mean for Small Businesses?
For small businesses, equity is essentially the valuable portion of the business that remains after subtracting liabilities from assets. The more equity a business has, the more valuable it is, and a healthy equity position is often one of the first things a lender or investor will look at when assessing risk.
Businesses can sometimes use this equity as leverage to raise investment, whether that’s through selling shares, securing asset-backed finance, or demonstrating financial strength when applying for a loan.
