Entrepreneurship and Small Business (ESB) V2 Certification Practice Exam

What is the formula for calculating equity?

1. Assets - Liabilities

2. Liabilities + Assets

3. Assets + Liabilities

4. Assets - (Liabilities + Equity)

The correct answer is: Assets - Liabilities

The formula for calculating equity is derived from the fundamental accounting equation, which states that a company's total assets must equal the sum of its liabilities and shareholders' equity. To isolate equity, you can rearrange this equation to show that equity is equal to assets minus liabilities. When you subtract liabilities from assets, you determine the net worth of the business. This amount represents what is owned by the shareholders after all debts have been paid. Therefore, understanding equity this way is crucial for evaluating the financial health and profitability of a company. In terms of the other options presented, they do not accurately represent the calculation of equity. Adding liabilities to assets or considering other incorrect combinations does not yield the net worth of the business and therefore does not reflect the shareholders' equity accurately.