Overview of Equity Examples
Equity also referred to as net worth basically determines what an entity owns.
In other words, equity can be defined as the degree of ownership an entity has in various assets (properties, machines, etc) after deducting all the associated liabilities (debts or loans).
Equity can be of various types:-
- Household Equity: for individual equity is determined by ownership in house and car.
- Shareholders’ Equity: for businesses the amount of money (capital) invested by the owners of the business in order to buy various assets. It is also referred to as owners’ equity
Note: The term shareholder’s equity is generally used for registered companies where shareholders basically are the owners of the company and have a claim over the company’s profits and losses. Every shareholder receives an amount of money in the situation of the company’s liquidation by selling all the assets and paying off all the liabilities.
Calculation of Equity
Equity tells us the financial health of the entity. That means whether an individual is financially stable and whether a company (or a business) is able to return the invested capital (ROE)
Basic Equity = What We Own – What We Owe
Shareholders’ Equity = Total Assets – Total Liabilities
Examples of Equity (With Excel Template)
Let’s take an example to understand the calculation of Equity in a better manner.
Equity Examples #1 – Household Equity
Mr. Robert Downey is a small farmer; he owns a house in the village with a home-loan on it, a tractor for his farming business and a motorbike (which he uses for both household and business purposes)
The current market value of his house is $200,000 and the amount of money he owed on a home loan is $100,000. The current value of the bike is $5000. The usage of a motorbike is 60% for business and remaining for household purposes.
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The tractor cannot be considered as a household asset, hence it will not be included in the calculation.
Solution:
Robert’s Equity
Equity = Assets – Liabilities
- Equity = $202,000 – $100,000
- Equity = $102,000
Note: Here equity can also be referred to as net worth.
Equity Examples #2 – Owners’ Equity
Mr. Robert Downey is a small entrepreneur in the business of iron crafting. In order to calculate the owner’s equity and create a balance sheet, he arranged the following data related to his proprietorship firm, Marvels Enterprises:-
Owns property worth $500,000, plant and equipments of $250,000, inventory = $50,000, debtors = $20,000.
Owes bank loan = $150,000, creditors = $55,000, other liabilities = $45,000.
Solution:
Owners’ Equity = Total Assets – Total Liabilities
Owners’ Equity is Calculated as:
Owners’ Equity = Total Assets – Total Liabilities
- Owners’ Equity = $820,000 – $380,000
- Owners’ Equity = $440,000
Note: The high equity value of the firm determines that financially the firm is healthy. Also, the firm has an adequate amount of assets to pay off its liabilities.
Equity Examples #3 – Shareholders’ Equity
Stark Inc is a well-established company tasked with the risk manager Mr. Robert Downey to Calculate the shareholder’s equity of the company. Mr. Downey has collected the following information from the annual reports of the company for the year 2018:-
Calculation of Shareholders’ Equity
Shareholders’ Equity = Total Assets – Total Liabilities
- Shareholders’ Equity =$ 76,191.53 – $34,705.67
- Shareholders’ Equity = $41,485.86
Equity Examples #4 – Return on Equity (ROE)
ROE: The ratio of ROE is a very important profitability metric that determines the investors about the income-generating capacity of the company from the money invested by the existing shareholders.
ROE = Net Income / Shareholders’ Equity
Mr. Robert Downey wants to invest $2 million in equity stocks. Aftermarket research, he picks two stocks: 1. Apple Inc and 2. Banana Ltd. Both are identical companies. He collects the following data to conduct a comparative analysis in order to select the more profitable stock out of the two. He decides to calculate ROE on both the stocks and invest in the stock with higher ROE.
Solution:
Apple Inc:
Calculation of Shareholders’ Equity
Shareholders’ Equity = Total Assets – Total Liabilities
- Shareholders’ Equity= $8,192,000 – $2,82,8000
- Shareholders’ Equity= $5,36,4000
Calculation of Return on Equity (ROE)
ROE = Net Income / Shareholders’ Equity
- ROE = ($9,70,000/ $5,36,4000) * 100
- ROE = 18.08%
Banana Ltd:
Calculation of Shareholders’ Equity
Shareholders’ Equity = Total Assets – Total Liabilities
- Shareholders’ Equity = $6753000 – $1784000
- Shareholders’ Equity = $4,96,9000
Calculation of Return on Equity (ROE)
ROE = Net Income / Shareholders’ Equity
- ROE = (9,40,000/ 4,96,9000) * 100
- ROE = 18.92%
Net Income: Apple Inc > Banana Ltd
($97000) > ($94000)
ROE: Banana Ltd > Apple Inc
(19%) > (18%)
Advice: However the Net income of Apple Inc is higher but ROE says that Banana Ltd is generating larger amount of income with the Equity Capital invested in the business. That means Banana Ltd is efficiently using its invested equity funds in order to generate higher profits.
Hence Mr. Downey should invest its funds in Banana Ltd based on higher ROE.
Conclusion – Equity Examples
Equity is basically a measure of the financial health of an entity because it informs the entity about the assets it owns that is actually going to generate future cash inflows and the liabilities it has to pay i.e. future cash outflows.
Equity is the difference between the assets and the liabilities. A negative figure suggests very poor financial health and a positive value says survival is possible but a high positive value suggests that assets are efficiently generating regular incomes and are capable of paying off its liabilities.
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