In accounting and finance, equity is the residual value or interest of the most junior class
of investors in assets, after all liabilities are paid; if liability exceeds assets, negative
equity exists.
In an accounting context, shareholders' equity represents the remaining interest in the assets
of a company, spread among individual shareholders of common or preferred stock; a negative shareholders'
equity is often referred to as a positive shareholders' deficit.
At the very start of a business, owners put some funding into the business to finance
operations.
This creates a liability on the business in the shape of capital as the business is a
separate entity from its owners.
Businesses can be considered, for accounting purposes, sums of liabilities and assets;
this is the accounting equation.
After liabilities have been accounted for, the positive remainder is deemed the owners'
interest in the business.
This definition is helpful in understanding the liquidation process in case of bankruptcy.
At first, all the secured creditors are paid against proceeds from assets.
Afterwards, a series of creditors, ranked in priority sequence, have the next claim/right
on the residual proceeds.
Ownership equity is the last or residual claim against assets, paid only after all other
creditors are paid.
In such cases where even creditors could not get enough money to pay their bills, nothing
is left over to reimburse owners' equity.
Thus owners' equity is reduced to zero.
Ownership equity is also known as risk capital or liable capital.
Equity investments An equity investment generally refers to the
buying and holding of shares of stock on a stock market by individuals and firms in anticipation
of income from dividends and capital gains, as the value of the stock rises.
Typically equity holders receive voting rights, meaning that they can vote on candidates for
the board of directors as well as certain major transactions, and residual rights, meaning
that they share the company's profits, as well as recover some of the company's assets
in the event that it folds, although they generally have the lowest priority in recovering
their investment.
It may also refer to the acquisition of equity participation in a private company or a startup
company.
When the investment is in infant companies, it is referred to as venture capital investing
and is generally regarded as a higher risk than investment in listed going-concern situations.
The equities held by private individuals are often held as mutual funds or as other forms
of collective investment scheme, many of which have quoted prices that are listed in financial
newspapers or magazines; the mutual funds are typically managed by prominent fund management
firms, such as Schroders, Fidelity Investments or The Vanguard Group.
Such holdings allow individual investors to obtain the diversification of the fund(s)
and to obtain the skill of the professional fund managers in charge of the fund(s).
An alternative, which is usually employed by large private investors and pension funds,
is to hold shares directly; in the institutional environment many clients who own portfolios
have what are called segregated funds, as opposed to or in addition to the pooled mutual
fund alternatives.
A calculation can be made to assess whether an equity is over or underpriced, compared
with a long-term government bond.
This is called the yield gap or Yield Ratio.
It is the ratio of the dividend yield of an equity and that of the long-term bond.
Accounting In financial accounting, owner's equity consists
of the net assets of an entity.
Net assets is the difference between the total assets of the entity and all its liabilities.
Equity appear on the balance sheet / statement of financial position, one of the four primary
financial statements.
The assets of an entity includes both tangible and intangible items, such as brand names
and reputation or goodwill.
The types of accounts and their description that comprise the owner's equity depend on
the nature of the entity and may include: Share capital
Preferred stock Capital surplus
Retained earnings Treasury stock
Stock options Reserve
Book value The book value of equity will change in the
case of the following events: Changes in the firm's assets relative to its
liabilities.
For example, a profitable firm receives more cash for its products than the cost at which
it produced these goods, and so in the act of making a profit, it is increasing its retained
earnings, therefore its shareholders' equity.
Depreciation - Equity will decrease, for example, when machinery depreciates, which is registered
as a decline in the value of the asset, and on the liabilities side of the firm's balance
sheet as a decrease in shareholders' equity.
Issue of new equity in which the firm obtains new capital increases the total shareholders'
equity.
Share repurchases, in which a firm gives back money to its investors, reducing on the asset
side its financial assets, and on the liability side the shareholders' equity.
For practical purposes, share repurchasing is similar to a dividend payment, as both
consist of the firm giving money back to investors.
Rather than giving money to all shareholders immediately in the form of a dividend payment,
a share repurchase reduces the number of shares in future income and distributions.
Dividends paid out to preferred stock owners are considered an expense to be subtracted
from net income(from the point of view of the common share owners).
Other reasons - Assets and liabilities can change without any effect being measured in
the Income Statement under certain circumstances; for example, changes in accounting rules may
be applied retroactively.
Sometimes assets bought and held in other countries get translated back into the reporting
currency at different exchange rates, resulting in a changed value.
Shareholders' equity When the owners are shareholders, the interest
can be called shareholders' equity; the accounting remains the same, and it is ownership equity
spread out among shareholders.
If all shareholders are in one and the same class, they share equally in ownership equity
from all perspectives.
However, shareholders may allow different priority ranking among themselves by the use
of share classes and options.
This complicates both analysis for stock valuation and accounting.
The individual investor is interested not only in the total changes to equity, but also
in the increase or decrease in the value of their own personal share of the equity.
This reconciliation of equity should be done both in total and on a per share basis.
Equity + net income inter net money one gained
− dividends how much money one gained or lost so far
+/− gain/loss from changes to the number of shares outstanding.
= Equity if one gets more money during the year or less or not anything
Market value of shares In the stock market, market price per share
does not correspond to the equity per share calculated in the accounting statements.
Stock valuations, which are often much higher, are based on other considerations related
to the business' operating cash flow, profits and future prospects; some factors are derived
from the accounting statements.
Equity in real estate The notion of equity with respect to real
estate comes the equity of redemption.
This equity is a property right valued at the difference between the marketof the property
and the amount of any mortgage or other encumbrance.
See also
Private equity References