Understanding Equity and How It Affects Stocks - Bookkeeping 101

Every type of business out there — whether it’s for-profit or a non-profit — has an owner or a set of owners. This is regardless of what industry the business is in. Aside from having the title of “big boss man” and bragging rights of owning a business, another thing that business owners have (which is the most important thing) is equity. Now, you might associate equity with stocks, shares, and returns, but it involves far more than making a quick buck.

In order to understand what equity is, and see how it impacts how a business works, let’s define what it actually is in the first place:

Equity made simple

To put it simply, equity corresponds to the value that represents exactly how much your business, with all its assets and liabilities, is worth. Businesses run their worth on equity because it’s simply a representation of your business’ power and performance after all debts and dues have been paid during the annual accounting or business cycle. The two main concepts that are related to equity are assets and liabilities, which play an integral part in determining the final value of a business’ equity over time. Let’s break down the significance of each part that makes equity what it is:

●     Assets correspond to what you have.

●     Liabilities are equal to the amount that you owe certain establishments, banks, and other service and product providers.

●     Equity is how much you have left over after all the necessary expenses have been reduced from your total assets.

A - L = E

If you’re familiar with basic accounting principles and business formulas, you probably understand what the combination of three letters, one minus sign, and an equal sign means. Known as the accounting equation, the formula of assets minus liabilities equals equity is a simplistic equation that can help you understand what’s going on in your business’ finances. It is so effective that even Fortune 500 companies stick to it religiously.

Do you have equity?

Well, whether or not your business is incorporated, and regardless of how big or small it is, every company has equity. This means that as a business owner you have equity, and you’ve had it ever since you started everything up. The standard guide for gauging how much equity you have (or if you have any at all) consists of identifying the value of all your assets (such as your physical or liquid cash, property, equipment, or materials) and subtracting the amount of liabilities you have from it. At times, the value that you get from subtracting your total liability from your total assets is referred to as the owner’s equity.

Incorporation and issuance of stocks

Ah yes, the main pieces of information that people want to know about when the topic of equity is brought into the conversation! On average, the typical business doesn’t keep track of its equity value until it incorporates. Aside from appointing directors, filing documents, and choosing a name to represent your business in the public eye, you must also issue shares of stock (unless you’re a non-stock corporation). The simplest explanation for how a stock works is that it’s a technical form of a little piece of your company (like a piece in a six to eight-digit jigsaw puzzle) that has a certain value assigned from it. How much it’s worth goes up and down according to how the corporation performs or fails. Your stocks can be offered by any member in your corporation’s board of directors to anyone at any time, regardless of how much they sell it for.

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Kelly Gonsalves