What Is Equity in Your Accounts and Why Is It Important?
Equity, in a nutshell, is the value of anything you – or your business – own after the amount of anything you owe is subtracted from it. So for example, if you have a vehicle worth £10,000 on which you still owe £4,000, the equity in that vehicle is £6,000. Equity in your business is important because it shows if your business is viable, and if your position is improving or failing.
There are two main ways equity is used in business finance, book value and market value. Book value is the difference between assets and liabilities – what you have and what you owe. Often called Owners Equity, it is the value of the business that would be left to the owner after all the liabilities are cleared.
Market value is often different to book value as it takes into account future projections and forecasts to determine the value of shares in a company and is a more intangible figure. It is generally used to evaluate the share value of a company rather than owners equity, but either way equity is an important indicator of your business health and should be monitored.
How to Calculate Equity
In terms of owners equity it can be calculated relatively easily as in its simplest form Equity = Assets – Liabilities.
Assets include items such as:-
- Stock in hand
- Property (physical or intellectual)
- Accounts receivable
- Debts – short or long term
- Fixed commitments
- Accounts Payable
- Wages owing
- Holiday Pay owing
- Tax and NI Liabilities
Market Value equity is more complicated to calculate but broadly speaking Equity Market Value = Total Number of Shares x Share Price.
This is not something that can easily be calculated, and professional advice should always be sought.
Why Is Equity Important?
More than most accounts, your equity is an important part of your business – and often the key indicator of whether your business is worth investing in. It demonstrates the health of your company.
Equity in a business can also be used to calculate how much you can borrow and whether your business can get a loan. The stronger your equity then the more favourable terms you will be able to negotiate to help expand your business.
How to Improve Your Business’s Equity
Improving business equity is simple to describe, but not always simple to do. Reducing your liabilities and /or improving your assets will improve your business equity. However that is not always easy, most businesses are cyclical and both liabilities and assets will fluctuate. The measure should be the trend of your equity over time, if it is increasing your business is improving, if it is decreasing then your business is likely to be failing and you should take steps to mitigate the situation.
One of the most effective steps you can take is to ensure you have a clear picture of your business health at all ties. Your bookkeeper or financial adviser can help you keep things in check and will often spot warning signs before you do. If you would like to know more about how professional guidance can improve your business health, give us a call and set up a free initial interview – simply click here and complete the form.