
Starting a new business? Get 40% off our accountancy services for 3 months! 😀
As accountants, we are naturally well-versed in the industry lingo. For those running their own businesses, it can sometimes seem like a whole other language. It’s why we began our Understanding Accountancy Terms FAQ series.
In this article we continue our quest for clear accessible accounting by looking at what equity means for businesses.
If you own a business, equity is basically the net worth of the business. To calculate equity, you need to know the value of a business’ assets and liabilities.
Assets are things that the business owns which have a value. These can include:
Liabilities are something that you need to pay in the future. These might be:
So where does equity fit into it? Well, there’s a formula for it:
The equity of a business is ‘what’s left over’ once the liabilities are deducted from the assets. In this sense, equity indicates the value of a business on paper.
It’s important to remember though, that a business usually isn’t worth just the equity on the balance sheet. There can be much more value not included, such as the company’s potential growth, market opportunities or the value of the customer base that the company generates.
Think of equity as the valuable bit of the business that’s left over from the assets once the liabilities are deducted.
The more equity, the more valuable a business is. Businesses can sometimes use this as leverage for investment.
When you own shares in a business, then you own equity and a share of the profits. If the business does well, then the profits grow, and so does the equity value.
A limited company which needs to raise money to finance growth might consider selling equities (shares) in the company.
The investor gives the business money for shares in the hope that their value will increase. Investors can then earn money on equities either by:
Owning shares entitles the shareholder to a proportion of the profits. These are paid as dividends, and are worked out in relation to how much of the business the shareholder owns.
A yearly tax-free Dividend Allowance allows someone to receive up to £2,000 of dividend payments each year.
Read our article about Dividend Tax to learn more about the Dividend Allowance, tax thresholds, and tax rates.
If the company grows and becomes more valuable, it means that the equity they own increases in value, too.
They can sell their shares for more than they paid, and make a profit (called a capital gain – read our article about Capital Gains Tax to learn more).
There are risks involved for both sides.
Like any investment, buying shares in exchange for equity carries a risk. The business might not perform as planned, so the value of the equity might decrease.
For a business, selling equity means that the original owner(s) must share the profits with the other shareholders. It also means that ownership is shared too, which can give shareholders a say in big decisions.
For instance, if you wanted to sell your share of the business then the other shareholders might have to agree to this. It can make it more difficult to make decisions or changes later on.
Putting a shareholder’s agreement in place makes it clear what shareholders are entitled to, and what rights and responsibilities they have regarding the business.
Some businesses create different classes of shares (sometimes known as alphabet shares). Our article about types of share classes explains this in more detail, but different share classes can be assigned different rights, such as:
Talk to one of our team about the online accountancy services we provide. Call 020 3355 4047, or request a call back when it’s convenient for you. You can even grab an instant online quote.
Subscribe to our newsletter to get accounting tips like this right to your inbox
This month we spoke to Adrian Manea, architect and director at Manea Kella, a London based RIBA Chartered architecture and interior design…
Read MoreWhen you own a business, it’s extremely normal to feel like you’re surviving one day to the next – ‘winging it’, as…
Read MoreHere at The Accountancy Partnership, we’re proud of our customer reviews The reviews we receive from our customers show how hard we…
Read MoreThe number of monthly transactions you have entered based on your turnover seem high. A transaction is one bookkeeping entry such as a sale, purchase, payment or receipt. Are you sure this is correct?
Please contact our sales team if you’re unsure
It is unlikely you will need this service, unless you are voluntarily registered for VAT.
Are you sure this is correct?
Call us on 020 3355 4047 if you’re not sure.
You only need this service if you want us to complete the bookkeeping on your behalf.
Would you prefer to complete your own bookkeeping?
Call us on 020 3355 4047 if you’re not sure.