Equity: what it is for and how to calculate

Did you know that knowing more about  equity  can help you in your investments? This is one of the accounting concepts that can be very useful in your life of financial applications.

PL analysis is an important component in the analysis of company balance sheets, but it can also be applied to your personal finances and investment fund applications.

Therefore, you will learn in this article what is equity, how it is used in the context of companies, how to apply this concept in equity appraisals and how to transpose this accounting tool into your personal finances .

In your family’s financial diagnosis, for example, do you know what your net worth is? How is it evolving year by year? Are you closer or further away from achieving those goals and targets that you have outlined for some time?

That’s what we’re going to find out soon.

Are you undecided as to whether it is worth following information that seems so far from your reality at first sight?

See the useful topics we’ll cover here:

  • How to understand what is equity in a company, in a fund and in your personal finances;
  • How to calculate net worth;
  • Example of equity;
  • What is the net worth of the investment fund;
  • What are capital reserves, equity valuation and profit reserves; and
  • How to use these accounting concepts to make your money pay more.

Come on? You will see that it is simpler than you think. Follow the reading and count on us to answer all your questions.

What is equity?

Equity is one of the most relevant concepts in a company ‘s balance sheet . Refers to accounts that show an entity’s book value. For this, it takes into account social capital, retained earnings, cash flow, among others.

Simply put, equity is the result of the difference between an entity’s assets and liabilities.

Let’s say you have an asset (assets and rights) of R $ 200,000.00 and a liability (obligations) of R $ 100,000.00. In this case, its net worth is R $ 100,000.00.

Isn’t it clear yet? Calm. We will untie these nodes by better understanding the group of accounts that make up the shareholders’ equity, the book value belonging to the shareholders or quotaholders.

Follow below:

Share capital

Share capital is the value of the consideration of the owner, partners or shareholders of an enterprise, for starting and maintaining the company. This value considers the amount necessary for the period until the business is profitable .

The Brazilian Micro and Small Business Support Service (Sebrae) defines social capital as follows:

“When a group of entrepreneurs get together to set up a business, it will be the initial own resources that will keep the company ‘alive’, while its customer base is not solid enough to support the company alone. Thus, this designation refers to the initial investment raised by the owners, corresponding to the company’s equity. This capital is modified each time a partner divests the company (capital reduction) or increases in invested capital ”.

The rules regarding the required amounts of share capital vary depending on the legal nature of the company.

Whoever is going to open an Eireli, for example, which is the Individual Limited Liability Company, must pay a share capital of 100 times the current minimum wage, which today means R $ 93,700.

In the modalities that do not require the immediate payment of the share capital, it is considered subscribed, that is, a promise made by the entrepreneurs at the moment of opening.

Payment is what makes the share capital part of the company’s net worth, whether through movable and immovable property and financial resources.

Capital reserves

Capital reserves, which form part of the PL, are designed with amounts received by the company and which do not refer to the result, as they are not linked to the production or delivery of services or business goods.

Equity Valuation Adjustments

Equity valuation adjustments result from the valuation of assets according to the calculation of their fair value.

This term, fair value, is the amount for which an asset can be exchanged for negotiation between two independent parties. It also serves to adjust liability settlement.

Profit Reserves

Profit reserves must be part of a company’s equity. They are accounts built from the company’s profits, to serve different purposes. They are constituted due to the legislation or proposal from the business management bodies.

Actions in Treasury

Treasury shares are those issued by a company and then repurchased by the same company, on the market.

Usually, the company decides to reacquire the papers to obtain shares destined to the employee incentive programs or to shareholder earnings.

Accumulated Profits or Losses

The accumulated profits or losses are the sum of the positive / negative results in the Profit and Loss Statements of a company since its incorporation.

These results are waiting for future absorption. According to Law 11,638 / 2007, for corporations , the final balance of this account can no longer be credited.

How to calculate net worth?

Equity is the calculation of the accounting entries of the company’s operation. It can change with each investment of values ​​in your business, for example, when there is an increase in social capital. In case of calculation of profits, also, the equity changes.

To calculate the equity of a company, just use an equation that takes into account the total assets and the payable liabilities. See how simple it is:

Equity = Assets – Liabilities

Below, we will better understand what assets and liabilities are and see an example of the calculation of shareholders’ equity in practice, so that you can apply this equation in your company or in the assessment of some balance sheet.

Assets, liabilities and shareholders’ equity

Understanding what is active and what constitutes liabilities is the first step in applying the concept of equity in your company or your personal finances.

Active

The asset consists of all the assets , rights and values ​​that an entity (company, for example) owns or has to receive. A new machine, for example, represents an asset. An own building where the factory works is also an example of a heritage asset.

More examples that constitute assets :

  • Duplicates (receivable from sales)
  • Properties
  • Vehicles
  • Machinery
  • Product patents

Passive

A company’s liabilities encompass all financial obligations that the business has with third parties. All debts are here. The purchase of a financed truck, for example, represents an obligation, a chargeable liability (and on the other hand, ownership is an asset).

Some examples that constitute liabilities :

  • Employee salaries
  • Taxes
  • Duplicates payable
  • Rentals to be paid.

Are the concepts of assets and liabilities clearer? Well, now for a demonstration of how they can be used in calculating equity.

Let’s say you invest in a property for a factory. The amount invested in the entrance is R $ 100.000,00 and the financed, R $ 200.000,00. In this case, you have an equity of R $ 300,000.00, but you still need to pay 2/3 of that amount, correct?

Then it is necessary to apply the Balance Sheet Equation : Equity = Assets – Liabilities.

Thus, the net result is R $ 100,000.00.

Example of equity

Below you will see an example that will make calculating a company’s net worth even easier to view. Prepared?

Take a fictional company called Modelo, which is a retailer of men’s suits and clothes. This is a partnership of a couple of entrepreneurs, Carlos and Fabiana.

The two invested a total capital of R $ 70,000.00. Of this amount, R $ 50,000.00 was paid into the property and into pieces for resale. The remaining R $ 20,000.00 was paid in.

With the initial work, the billing reached R $ 40,000.00, which later represented a profit of R $ 22,000.00.

Let’s see how our net worth is doing so far ?

Share capital = R $ 70,000.00

(-) Capital to be paid in = R $ 20,000.00

(+) Retained earnings = R $ 22,000.00

Total shareholders’ equity: R $ 72,000.00.

Then, when the couple decides to pay the rest of the share capital, we will have the following equity:

Share capital = R $ 70,000.00

(+) Retained earnings = R $ 22,000.00

Total shareholders’ equity: R $ 92,000.00.

Of course, this example is much simpler than thoroughly analyzing all the elements of a Petrobras balance sheet.

But understanding concepts like equity can be a first step towards your accounting education, which will count valuable points in your investor journey.

How is the net worth of an investment fund calculated

Investment funds are condominiums that promote the collective application of the resources of its participants.

Thus, shareholders’ equity is the sum of all resources invested in by their various investors, discounting all obligations, including those related to their management (such as the management fee).

In practice, the sum of the amounts invested in the fund constitute your assets. The money invested is converted into quotas , which are fractions of that total amount. Thus, each investor receives a number of shares according to the contribution of resources.

Let’s say you invest R $ 60,000.00 in shares of an investment fund. On that date, the fund has a net worth of R $ 800 million and 5 million quotas.

These data allow some conclusions. The value of the quota is given by dividing the equity by the number of shares: 800,000,000 / 5,000,000 = R $ 160.

In this case, you will receive 375 shares from the bottom of the example. The result comes from the following equation: number of quotas = applied value / quota value.

Simple, isn’t it ? Have you seen how equity has numerous applications for your life as an investor? Next, we will understand how to put the concepts learned in this article into practice.

Personal net worth

Understanding what equity is can be very useful for your life as an investor, as a first step in this universe of accounting. But it can also be very important in your personal financial organization , that is, in your family accounts.

We have already seen that the equity equation is very simple:

Equity = Assets – Liabilities.

So, how to use it to analyze your financial statement and adjust the accounts to invest more and better?

The net worth allows to verify the financial evolution of a person and his family. But to do this correctly, you need to spend some time on the task.

With this exercise, you will be able to determine what your true wealth level is and how far you are from achieving your financial goals and objectives.

For example, if you have a specific goal of owning a certain asset, you cannot just look at your bank account balance. If you want to be a millionaire and have exactly R $ 1,000,000.00 in your bank, you may not have actually gotten there yet.

What will determine how much you actually have is this calculation of equity, which takes into account all your liabilities .

For example, you can have this amount in your account while paying the financing of R $ 300,000.00 for a house and R $ 80,000.00 for a car. In this case, the dream of the million is on its way, but it has not yet come true.

So let’s take a practical example here considering a family’s accounts.

Family assets

  • House (market evaluation): R $ 500,000.00
  • Car 1 (market assessment): R $ 40,000.00
  • Car 2 (market assessment): R $ 80,000.00
  • Balance in CDB: R $ 100,000.00
  • Savings balance: R $ 20,000.00
  • Current account balance: R $ 10,000.00.

Total assets : R $ 750,000.00.

Family liabilities

  • Balance due for financing the house: R $ 50,000.00
  • Balance due for car financing 2: R $ 30,000.00
  • Credit card debit balance: R $ 10,000.00.

Total liabilities : R $ 90,000.00.

Okay, now let’s go to the balance equation:

Equity = Assets – Liabilities .

Net equity = 750,000 – 90,000 = 660,000

See, this is the current situation of your wealth: R $ 660,000.00. You can use this data to compare the evolution of your assets annually and update this information periodically, to get a good idea of ​​how your finances are doing.

This analysis will also help you to see the financial situation through this magnifying glass of assets and liabilities. In the example above, wouldn’t it make sense to use the savings money and part of the CDB to pay off home and auto financing?

It all depends on interest . If investments pay more interest than is consumed in financing, that’s fine: you can keep the situation as it is.

But if financing is causing more losses than investments are resulting in gains, it is worth contacting financial institutions to determine what the total amount would be to settle debtsand, thus, promote a more positive flow in the accounts.

Equity in Income Tax

You can use the IRS program to help organize your personal equity, did you know? This is a tip from the CEO of Sevilha Contabilidade, Vicente Sevilha Junior, in an interview with G1.

“The IRS program has a table called Goods and Rights, where all movable, immovable, rights and obligations that, in Brazil and abroad, constituted the patrimony of the individual in the calendar year must be listed”, explains the Income Tax specialist.

This strategy can be useful to help organize all the numbers that involve your personal finances. Just don’t confuse your equity analysis with your Income Tax return.

The valuation of real estate and automobiles, for example, should not be corrected in the declaration. In your own balance sheet, it is important to take into account the market price ofthese goods.

Conclusion

You have learned how to use the concept of equity to determine the true situation of a company , an investment fund and its personal finances. You will now be able to use this accounting tool to make better financial and investment decisions.

As it is an extensive content and not always so easily digested, shall we review the main elements of this guide? It is good to keep the main topics well:

  • Equity = Assets – Liabilities;
  • Equity formula is also called balance sheet equation;
  • Social capital is the initial value for starting and maintaining the company’s activities before the business generates a profit;
  • The asset is all the assets, rights and values ​​that an entity has to receive;
  • Liabilities are all of a company’s financial obligations;
  • Analysis of the evolution of equity helps to monitor the evolution of the finances of a company or a family;
  • Financial diagnosis of a family’s assets and liabilities helps to make better investment decisions; and
  • You need to weigh the interest on the asset and liability accounts to determine the best direction for your finances.

Well, now that you are more used to some accounting terms and have seen how it can be useful in your investment journey, how about taking more steps towards your financial and economic education?

Let’s suggest reading some posts on our blog, which will help you to make better and better decisions, which will make your money grow in a sustainable way and with little risk.

How about starting with a basic guide on the Selic Rate ? Then, who knows, look around and see if this post on the stock exchange interests you.

We also have a guide on fixed income that can be a very important gateway for those who want to obtain returns much higher than savings accounts.

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