Accounting and Key Figures
What is Equity? An Explanation with a Simple Example
Equity is the accounting value that remains when a business's liabilities are deducted from its assets.
2 min read · Translated from Norwegian. Read the original
Equity is the accounting value that remains when a business's liabilities are deducted from its assets.
Equity = Assets − Liabilities
If a company has assets of 8 million NOK (Norwegian Kroner) and liabilities of 5 million NOK, the book equity is 3 million NOK.
Contributed and Earned Equity
Contributed equity comes from the owners, for example, share capital and share premium. Earned equity is built through previous profits that have not been distributed, reduced by losses and distributions.
In a limited company (aksjeselskap - AS), share capital is just one part of the total equity. It does not solely indicate how much cash the company has or what the company is worth.
What Affects Equity?
- Annual result
- Dividends and other distributions
- Capital contributions
- Capital reduction
- Certain value changes and reorganisations
A positive annual result normally increases equity if it is not distributed. Losses reduce it.
Negative Equity
Negative equity means that book liabilities are greater than book assets. This is a serious signal, but not the same as bankruptcy. Bankruptcy requires a separate assessment of insolvency and ability to pay.
The board of directors in a limited company (aksjeselskap - AS) must monitor whether equity and liquidity are sound in relation to the business's risk and scope. In cases of financial pressure, assessments and measures should be documented.
Book Value and Market Value
Book equity is based on accounted values. The market value can be different. Expertise, customer base, and proprietary technology can have value without being fully visible on the balance sheet. Assets can also be overvalued or difficult to realise.
How Proffi Should Display Equity
Show the amount, equity ratio, history, currency, and whether the figures apply to the company or the group. Explain significant changes with available accounting entries and link to the source.
Frequently asked questions
- Is share capital money that must remain in the bank account?
- No. After incorporation, the capital can be used in the business within the applicable rules.
- Is high equity always good?
- It often provides a buffer, but capital must also be used efficiently. Consider profitability and risk simultaneously.
- Can a company with positive equity go bankrupt?
- Yes. If it cannot pay its obligations and the conditions for insolvency are met.