Definition of Equity
Shareholders' (UK) or stockholders' (US) funds represent the equity of a business. It is the sum of paid up capital plus taxed profits retained in the business.
Equity and the Balance Sheet
Net assets in the balance sheet will always equal equity. Negative equity must be avoided at all costs: It is the principal definition of insolvency.
Equity is a liability as it represents the capital and retained taxed profits invested in the business by shareholders / stockholders and therefore owed to them. The value of equity also demonstrates the extent to which the assets of a business are supported by its investors.
Equity Debt and Dividends
The ratio between total liabilities and equity i.e. debt / equity is a significant measure of the leverage of a business in respect of its operating debt and external finance such as loans and bank overdrafts. It is important to forecast the change to this ratio before making decisions on significant investments or to reducing the equity of the business by distributing dividends.