What is Equity? A Comprehensive Guide to Ownership, Value, and ROE

Equity is the investment or ownership capital in a company.

Equity usually refers to ownership in a public company. Simply put, equity means share or stock.

Let’s clarify with an example:

Suppose you buy 30% of a company's total shares, you now own 30% of that company. In other words, the company has taken a loan of that equivalent amount from you by issuing 30% of its shares.

In accounting, equity is what remains after subtracting all liabilities from a company’s total assets.

In financial statements, equity is listed at its book value, and calculated through the accounting equation.

Formula:

Equity = Total Assets – Total Liabilities

For example, during a company's liquidation, once all assets are converted to cash and liabilities are paid off, the remaining amount returned to shareholders is considered equity.

In finance, equity is shown at market value, which may be much higher or lower than book value.

If a company has 100,000 outstanding shares, and the current market price per share is Tk 50, then the market value of the company's equity is:

50 x 100,000 = Tk 5,000,000

To understand equity properly, it is important to differentiate between Owner’s Equity and Shareholders' Equity.

Owner’s Equity:

Refers to the control or capital an individual owner has in the business. Sole proprietorships and partnerships commonly use this type of equity.

For example, in a partnership business, if you own 70% and your partner owns 30%, then your equity in the business is 70%.

Shareholders' Equity:

Also known as stockholders’ equity, used by corporations.

Shareholders’ equity is the value of a company’s assets after all liabilities have been deducted.

Example:

As per AXON company's balance sheet on 31/12/2021:

Total Assets: Tk 2,300,000,000

Total Liabilities: Tk 800,000,000

So, Equity = Tk 1,500,000,000

Which means shareholders own 65% of the company's total assets.

Apart from the two types above, there's also Private Equity, which refers to the valuation of companies whose shares are not traded publicly. These companies sell shares directly through private placements. Investors may include pension funds, university endowments, insurance companies, or accredited individuals.

Private Equity is divided into two types:

Home Equity:

Refers to how much of a home or apartment an individual owns.

For example, if your apartment's current market value is Tk 4,500,000 and you still owe Tk 1,500,000 in mortgage debt, your home equity is:

4,500,000 – 1,500,000 = 3,000,000

Brand Equity:

Explained with an example:

Many soft drink consumers would reach for Coca-Cola over Mojo because they prefer or are more familiar with Coca-Cola’s taste.

If Mojo’s 2-liter bottle costs Tk 60, and Coca-Cola’s 2-liter bottle costs Tk 120, then Coca-Cola’s brand equity is Tk 60.

When a company needs money to buy assets, invest in projects, or run operations, it can:

• Take loans
• Issue bonds
• Or issue equity (shares/stocks) to raise capital.

This is how companies raise money by selling shares or stocks.

On the other side—who buys these shares or stocks, and why?

Various investors buy them.

Investors usually look for equity investments because they provide an opportunity to share in the company’s profit and growth.

To determine how effectively a company is using its equity, we look at its Return on Equity (ROE).

ROE = Net Income / Shareholders’ Equity

Example:

AXON Company

For the fiscal year ending 31 December 2021:

Net Income: Tk 300,000,000

Starting Equity Balance: Tk 600,000,000

Ending Equity Balance: Tk 650,000,000

Average Equity = (600,000,000 + 650,000,000) / 2 = 625,000,000

ROE = 300,000,000 / 625,000,000 = 48%

The higher the ROE, the better.

Stock and equity are essentially the same, as both refer to ownership in an entity (company) and are traded on stock exchanges.

By definition, equity means ownership of assets after debt is paid off. Stock usually refers to tradeable equity.

So, equity can also mean stock or shares.

Although the dictionary meaning of equity is "fairness" or "equality," in accounting and finance, the meaning is quite different.

To understand a company’s ownership structure and earning potential, knowledge of equity is essential.

While the literal meaning of "equity" is simple, its use in accounting and finance is complex and significant.