Managers need to calculate a company’s assets, liabilities, and equity to make decisions for the benefit the company. This procedure is called equity management and is essential for any entity to continue its operations for an extended period.
What is Equity Management?
It is the management of the company’s assets after deducting the total liabilities. Assets are all the properties or resources of a firm that has tangible value. Each of its value depends on its market value at the moment of calculation. Liabilities, on the other hand, are the sum of all debt that the entity owes. To calculate equity, you simply subtract the total amount of liabilities from the company’s assets.
The importance of performing equity management is to maximize the company’s equity and try to inflate it as much as possible by following forecasts that were previously done. Managers need to prepare for any foreseeable risks.
Once managers have determined equity, they then need to decide on what to do with it. They can invest it in incremental amounts, then reinvest when the time is right. To help them make an informed decision, they may conduct market predictions through technical algorithmic calculations or using business intelligence software or regression analyses of the potential markets.
For example, a company earns 20 million USD in a specific year but also holds 15 million USD worth of liabilities. Once they subtract the liabilities, the firm is left with 5 million USD, which is now its equity. When managers have reviewed the accuracy of the calculations, they must then make an equity plan to decide on what to do with it. If they choose to invest 50% of the total equity after carefully predicting potential value, return and/or stock fluctuations, they may then do so in incremental amounts.
There are various types of equity. Equity is also referred to as shareholder equity, which represents the total amount of money that shareholders would receive if all the company’s assets were liquidated, and all its existing debts were paid off. It can also represent the company’s book value.
Before people decide to invest in a firm, they first need to know its financial stability because they must determine the risks involved.
Equity in Accounting
In accounting, equity is all of the company’s tangible assets, which means it is in physical form and can be touched, and intangible assets, which are those that you can’t hold but are just as valuable. Here are a few examples of each type:
- Accounts Receivable
- Trade names
- Customer lists
- Brand Recognition
- Goodwill (factors that affect the brand’s value)
The difficulty with intangible assets is that there is no definite number ascribed to its value. Companies have to determine the value of the intangibles using various methods, such as:
This process is done by calculating how much it would cost for another company to recreate the same intangible asset. In the calculation, employees can either estimate the present-day costs to duplicate the asset or calculate the exact present-day value of all original costs.
Similar to the previous method, the company must take a look at another business’s intangible assets. One can use the other company’s value as a point of reference.
The firm can measure the future benefits that the intangibles can bring to a different company. To do so, managers need to make use of cash flow projections.
To calculate equity, you must also get the total liabilities. Here are some examples of liabilities:
- Accounts Payable
- Wages and salaries
- Unearned revenues