What is equity? Definition and examples
Equity is the ownership of any asset after any liabilities associated with the asset are cleared. For example, if you own a car worth $25,000, but you owe $10,000 on that vehicle, the car represents $15,000 equity.
It is the value or interest of the most junior class of investors in assets.
If liabilities still exceed assets then there is negative equity and if assets exceed liabilities there is positive equity.
Equity is also what a shareholder owns in a corporation, entitling him or her to part of that entity’s profits (dividends) and a measure of control (shareholder voting rights).
The word ‘equity’ is used in several financial compound terms. For example, ROE, which stands for return on equity, compares a firm’s net profit directly to the value of its equities.
Businesses can be considered sums of liabilities and assets (the accounting equation) for accounting purposes. When business owners start funding operations in their business this creates a liability on the business in the form of share of capital (as the business is its own separate entity).
This concept is important, because when companies file for bankruptcy secured creditors are paid against the proceeds from assets. Ownership equity is the last claim against assets (paid after all creditors have been paid).
Ownership equity is also known as liable capital or risk capital.
The meaning of the term equity also depends on the context of its use. A car or house with no debt left to pay is the owner’s equity because he or she can go ahead and exchange the item for cash.
Examples of the different natures of entity include:
- Preferred stock
- Share capital
- Capital surplus
- Retained earnings
- Treasury stock
- Stock options
- Reserves
In non-financial English, ‘equity’ means the quality of being impartial and fair, as in this sentence “That company is an example of equity – it treats people the same and pays them equally for doing the same job.”