Equity is a type of account found on the balance sheet and equity belongs to common stockholders when the business is in the corporate form. When something beneficial, financially speaking, happens to the company, the amount (balance) of the equity account goes up. When something negative, financially speaking, happens to the company, the equity balance goes down.
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You don’t need to be an accountant to understand the notion of how financially positive or negative events can create an account balance. Think about your checking account balance that you track in your check register. When you add money to your checking account, you increase the balance in your account. When you spend (take) money from the account, you reduce the balance in your account. At any point in time, the balance in your account represents how much money you have in that account. That is, the balance shows what your account is worth at a point in time.
Now, think about the equity account balance on a balance sheet working similarly to your checking account balance. As with your checking account balance, a company’s equity account balance goes up and down with financial events. Also, the balance in the equity account shown on a balance sheet, at a point in time, reflects its (accounting) worth just as the balance in the checking account shows the worth of that account at a point in time.
In my analogy of company equity and your checking account, we must consider a few additional aspects for the company equity account. First, it is found on the company balance sheet and not on a check register. Second, the equity balance is not completely comprised of cash as is the case with a checking account balance. Third, the equity account balance reflects a balance belonging to many people (shareholders) whereas your checking account balance belongs to only you. These additional aspects make it a bit more involved in figuring out what your individual worth is as a partial owner of the equity balance shown on the balance sheet of a corporation than determining your individual worth with the checking account.
Here’s the thing. You have to know your checking account balance to know what it is worth at any point in time. If you are going to buy common stocks, you have got to observe, to the best of your ability, what your part of the company’s equity balance is worth at any point in time…..so analysis of a company’s balance sheet is essential before buying stocks. My book, Choose Stocks Wisely: A Formula That Produced Amazing Returns, was written for the purpose of showing exactly how I ascertain the value of “a” piece of equity (a common stock) share before I make it “my” share via stock purchase.
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