What is Equity

What is Equity? Equity is a term used in accounting, in real estate and home-ownership, in investing, as well as in startup financing and valuation. The meaning of the term equity is very similar in the various areas where it is used, so it will be good to review all four of these to get the best understanding.

In accounting, equity is a term that you will find on the balance sheet. What you own is on the left: assets. What you owe is on the right: liabilities and equity. Equity is the book value of the shareholder capital. The accounting equation tells you that assets equal liabilities plus equity. That also means that equity equals assets minus liabilities.

Equity on a balance sheet goes up when a company is profitable: the net income for the year gets added to equity through retained earnings. Equity on a balance sheet goes down when the company is loss-making (losses “eat up” the equity), or when the company pays a dividend to its shareholders.

Equity in home-ownership works very similar to equity on the balance sheet. What we own is on the left: the house worth $500.000. What we owe is on the right: $400.000 of mortgage loan from the bank, and the owner of the house, Jim, has $100.000 of equity in the house. Equity in home-ownership is what a home is worth minus how much you owe to the bank.

Just like equity on the balance sheet of a company can go up or down, the equity that you have in your home can go up or down. If Jim is paying down the mortgage on his house by $50.000, then the amount of the loan outstanding will decrease and his equity in the house will increase. If the market value of the house increases, then Jim’s equity in the house will increase. Remember that equity is what a home is worth minus how much you owe to the bank. If the market value of the house decreases, then Jim’s equity in the house will decrease, or even become negative. Jim will need to have a conversation with the bank to make a remediation plan to get back to positive equity, or in the worst case scenario Jim might lose the ownership of the house and the bank will need to take a partial write-off of its outstanding loan.

Investing in #equity. Remember the example of the small manufacturing business that owned a machine, had a loan from a bank, and equity from one shareholder. What if we make that a big manufacturing business that owns lots of machines at different sites totaling $1 billion, has many loans outstanding totaling $800 million that are publicly traded in the bond market, and has many different shareholders as the certificates of ownership, the equity, is traded publicly as well. As an investor, you have the choice of buying bonds (which would have a predetermined interest rate, and has the machines as collateral), or the choice of buying stocks (which are perceived as having more downside risk as well as more upside potential). Invest in debt, or invest in equity.

Equity in a startup company. How do you put a “price” on what is essentially so far just an idea, that still has to be developed and will find many ups and downs along the way? The company does not have any assets, liabilities and equity yet. The financing and valuation depend on the estimate of the revenue, profit and cash flow that the business idea might bring in the future. A good way to learn about startup companies in the tech field is the comedy series “Silicon Valley”. What happens if the app you are developing turns out to have a great compression algorithm, you are courted by investors ready to fund you, and your friends and roommates suddenly become your employees while you become the CEO?

Having equity can be a great thing. Equity has potential risks as well as potential rewards. The term equity is used in accounting, in home-ownership, in investing, and in start-up financing and valuation. Probably the easiest metaphor to remember is equity in home-ownership: what a home is worth minus how much you owe to the bank.

Philip de Vroe (The Finance Storyteller) aims to make strategy, #finance and leadership enjoyable and easier to understand. Learn the business and accounting vocabulary to join the conversation with your CEO at your company. Understand how financial statements work in order to make better #investing decisions. Philip delivers financetraining in various formats: YouTube videos, classroom sessions, webinars, and business simulations. Connect with me through Linked In!

[chellyvino]

So frickin simple. This is what I was struggling to understand in my accounting and business finance classes.

[mumbibabyz]

Simply explained. I've had a hard time understanding equity but with this video, I understand 100%

[kyleangove]

Here’s how I stay lost. You provide a definition to a word I don’t know, and in that definition, there are more words I don’t know the meaning of. So I look them up and there are different definitions and meanings to the word. Example, I just looked up equity for a definition and now I’m watching this video and now I’m more lost

[bassem]

omg, I cant believe this word made me not understand so many concepts just because it wasn't properly defined in the first place. Thanks buddy!

[SusanFuller.]

Now I have an indepth knowledge of how equity works. Nice.

[sebastiansudacki]

The 'investing in equity' section helped me a lot, a very clear picture. Thanks!

[jr.rasentertainment]

I used to study Equity in college. Now that I am investing in my own business I know understand what it is all about. Thank you very much for the information. Watching all the way from Vanuatu 😃😁👍🔥🔥🇻🇺🇻🇺🇻🇺

[starseed]

Thank you. I feel like my brain went on autopilot every time someone said equity before. I truly appreciate this explanation as it definitely had more facets than I had anticipated

[konstancyja]

And using my favorite series for example.... Great! Simple and clear, as usual!

[Rayis]

I can’t thank you enough. I have been struggling to understand this simple concept for the longest time.

[oliverkhoo]

Your channel is underrated, thanks for the content.

[Dbennett]

That was awesome man. Equity versus debt is now understood!

[harryfire]

3:22 thank you for the very clear examples and explanations

[JoshCamacho]

Thank you! Just started accounting and this really helped clear up what equity was! very helpful!

[bobbywatson]

Online school made this really dull and hard to understand but this video makes it so so simple thank you so much !!

[indianweeboo]

Thnx, this concept was never explained in my accountancy class

[munib]

So Simple, bonds = invest in debt and stocks = invest in equity. Thank you.

[MellodieNoaes]

So smooth and clean blow of understanding into my mind

[Shawns]

that opened up an entire part of the money world i had no idea of

[jj-buyb]

I'm learning a lot! Thanks teacher ♥️ may God bless you