As part of our efforts to educate and inform our readers, we at OnlineAdvisor.com provide some beneficial financial literacy information. We present topics and concepts which affect our readers so that they can make the best decisions. This brief description of equity is part of our financial literacy efforts.
This information may seem very simplistic. We intend it to be simple. Many resources, including Investopedia, present excellent definitions for readers. However, their content is not only for executives, owners and managers. They also present content for investors as well.
We don’t want to confuse our readers, so we focus here on what equity means for those involved in business – not in investing.
Equity usually represents the amount of the funds contributed by the owners (the shareholders) plus the retained earnings. This money is also called stockholders’ equity or shareholders’ equity.
If you start a company, you need to put some cash into the company to get it running. That cash is usually all of your equity when you start. As you make money, you decide whether you keep money in the company or not. The money that stays in the company becomes part of the equity. That money is now categorized under “retained earnings.”
This may be a good time to briefly explain how retained earnings work in this system. Again, retained earnings represent the money or assets that owners or shareholders decide to leave in the company. They play a role
For example, if a company makes $100,000 in a given year, the shareholders may choose to take $70,000 as “distributions” and then leave $30,000 in the company. In most cases, shareholders leave money in the company for various future needs. In many cases, they leave money in the company so it has additional cash to buy more inventory or equipment. The $30,000 kept by the company is categorized as “retained earnings”.
Talk to an accountant and they will think of equity as part of a famous equation. Equity is the value of an asset (or company in this case), less the amount of all liabilities on that asset (or company). This equation explains it: Assets -Liabilities = Equity.