What is equity in business?
Equity Is a common term which is sometimes misunderstood in Business and commercial real estate Investment. Then what is equity in the business?
The simple definition of equity.
The simple definition of equity is the accounting equation as follows;
Total Assets minus total liabilities = Equity
The assets are what the actual business owns. Liabilities are what the business owes to others.
Equity is what you as the business owners have. It is the ownership interest and a net value of the business with debt taken out.
For example, You own a restaurant with a current valuation of $500,000, which was initially purchased for $400,000 with a loan of $200,000. Therefore, your current equity balance is $300,000. This represents a $100,000 increase in equity since the purchase of the restaurant.
On the other hand, if the current valuation drops down to $300,000, your equity balance would be $100,000.
Shown as follows;
Original price of restaurant $400,000
Value valuation of Restaurant $300,000 (less)
Current equity balance $100,000
On a business or company balance sheet, equity is shown as the value of assets and stock plus profits (after any distribution to shareholders/owners) less the business liabilities.
What is negative equity?
Negative equity is when the liabilities or debts are more than the total assets. This is not a good position to be in. It severely limits your growth potential reducing your ability to raise funds for any expansion plans. It also makes your business less attractive to buyers resulting in a business having very little if any value.
For example, you may own a small business cafe with a current value of $200,000. Unfortunately, the business has fallen lately, and your debts have grown to $250,000. You have spent a large amount of money on renovations and equipment with little improvement in profits.
In the above example equity is $200,000 (value of business) less $250,000 amount owing. This equals to a negative equity amount of $50,000.
How can equity be used to help the business?
It is essential businesses have a policy of building up equity to create more growth options for you.
If the amount of equity increases in value, so does your line of credit Increase. It is allowing you to borrow more money for the property and business. These additional funds can be used to purchase new equipment or upgrade the premises. Managed correctly, this should, in turn, attract increased cash flows, higher profits and more importantly, higher net worth.
How is the market value of equity determined?
When a company is publicly traded on the public stock exchange, market value is simple to calculate. You find out the current share price. This figure is then multiplied by the sum of shares outstanding.
Working out the market value for a private company is more complicated. There needs to be a formal valuation done. This is carried out by detailed analysis by qualified valuers, specialist accounting groups or investment bankers.
In the finance industry equity is reported as market value. This value can either be higher or lower than the book value. This occurs because accounting financial statements look at past results. On the other hand, finance analysts work on anticipated future performance to determine the value of equity.
How is commercial business equity different to residential equity?
Generally, Financial lenders seem to be more cautious with their approach to equity for commercial businesses than for residential loans. Banks are aware that business conditions and values can change quickly, along with the risk.
What are tangible and intangible assets?
In commercial business, equity represents tangible and intangible assets/equity.
Tangible assets on the balance sheet can include the Commercial real estate if the property is owned along with the furniture and fittings and equipment. They are the actual solid objects visible. On the other hand, Intangible assets are items not very obvious when first observed. They can include things such as Goodwill, Client/customer database and the other intellectual property owned by the business.
Intangible equity usually takes time to build up – usually, many years of goodwill servicing regular customers.
What items are included as Liabilities?
Liabilities can be current or non – current when setting out in balance sheets/ financial statements. They would include short term debt, long term debt, deferred revenue, capital leases, lines of credit, accounts payable or any other obligation for future payment.
How to increase your business Equity?
The above information outlines the advantages of growing equity in your business. The basic formula is to have good sound management. Continually work on increasing your customer base with cost-effective and strategic marketing to increase revenue while keeping close tabs on your costs.
Business conditions change all the time. Ensure that you stay in control of your finances and your fellow owners and bank manager will love you for it. More importantly, a higher payout for you when the eventual time comes for you to sell.
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