Equity (finance) facts for kids
Imagine you own something valuable, like a cool bike or a video game console. If you bought it all by yourself, you own 100% of it. That's your equity!
In the world of money, equity means owning a part of something, like a car, a house, or even a business. It's the value of what you own after you subtract any money you still owe on it.
Here's an example: If your family has a car worth $24,000, but they still owe $10,000 on a loan for it, their equity in the car is $14,000. That's the part of the car they truly own.
Equity can be for one item, like a car or a house. It can also be for a whole business. When a business needs money to grow, it can sell parts of its ownership (equity) to investors. This money doesn't have to be paid back like a loan.
Sometimes, if you owe more money on something than it's worth, it's called being "underwater." For example, if a house is worth $200,000 but you still owe $220,000 on it, you have negative equity.
Contents
What "Equity" Means
The word "equity" comes from old English law. Long ago in England, there were special courts that dealt with fairness in agreements, especially about property. These courts made sure that deals were "equitable," meaning fair. So, "equity" came to mean a fair share of ownership.
Equity in Your Stuff
When you buy something big, like a car or a house, with a loan, you don't fully own it until the loan is paid off. The bank or lender has a claim on it. Your equity is the part you truly own.
Let's say you buy a house. You pay some money upfront (a down payment), and a bank lends you the rest. As you pay off the loan, your equity in the house grows. If the house's value goes up, your equity also increases!
You can even use the equity in your house to get another loan. This is called a home equity loan. It means you're borrowing money using the part of your house you already own as a guarantee.
Equity in Businesses
For a business, equity is a bit more complex. It's still the value of what the business owns after subtracting all its debts. This is sometimes called total equity.
Think of it like this: A business has assets (things it owns, like buildings, equipment, or money) and liabilities (money it owes to others). The difference between what it owns and what it owes is its equity. This equity belongs to the owners of the business.
How Businesses Track Equity
Businesses keep track of their money using something called accounting. They have a special report called a balance sheet. This report shows everything the business owns (assets) and everything it owes (liabilities). The balance sheet always balances:
Assets = Liabilities + Equity
This means that the total value of everything a business owns must equal the total of what it owes plus what its owners truly own.
There are different types of equity listed on a balance sheet:
- Money from owners: This is the money investors first put into the business.
- Retained earnings: This is the total profit the business has made over time, minus any money paid out to owners.
- Treasury stock: This is when a company buys back its own shares from investors. It reduces the total equity.
Many things can change a business's equity:
- New investments: When new investors put money into the business, its equity goes up.
- Profits or losses: If a business makes a profit, its equity increases. If it loses money, its equity decreases.
- Dividends: When a business pays out some of its profits to its owners, its equity goes down.
- Buying back shares: If a business buys back its own shares, its equity goes down.
Investing in Equity
When people talk about "equity investing," they usually mean buying stock in companies. When you buy a company's stock, you become a part-owner of that company.
As a stock owner, you might get:
- Dividends: These are small payments from the company's profits.
- Capital gain: This is when you sell your stock for more than you paid for it.
- Voting rights: You get to vote on important company decisions, like who is on the board of directors.
When a new company starts, investors put in money to get it going. In return, they get shares of the company's stock. This money is their ownership interest. If the company does well, the value of their shares (their equity) goes up.
If a company has to close down, the owners (shareholders) get what's left after all the debts are paid. This is called a "residual claim." If there's nothing left after paying debts, the owners don't get anything. But usually, owners are not responsible for the company's debts themselves. This is called "limited liability."
How Stock Value Changes
The value of a company's stock doesn't just depend on its accounting equity. Many other things affect its price, like:
- How well the business is expected to do in the future.
- Any risks the business faces.
- How easy it is to find someone to buy the stock.
Some famous investors, like Warren Buffett, believe it's smart to buy stock when its price is lower than what the company is truly worth. Even if a company has negative equity (meaning it owes more than it owns), its stock price will never go below zero, because owners are not responsible for the company's debts.
See also
In Spanish: Recursos propios para niños
- Private equity (a type of investment)
