Equity (finance)
Encyclopedia
In accounting
and finance
, equity is the residual claim or interest of the most junior class of investors in asset
s, after all liabilities are paid. If liability exceeds assets, negative equity
exists. In an accounting context, Shareholders' equity (or stockholders' equity, shareholders' funds, shareholders' capital or similar terms) represents the remaining interest in assets of a company, spread among individual shareholder
s of common
or preferred stock
.
At the 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 asset
s; this is the accounting equation
. After liabilities have been accounted for the positive remainder is deemed the owner's interest in the business.
This definition is helpful in understanding the liquidation
process in case of bankruptcy
. At first, all the secured creditor
s are paid against proceeds from assets. Afterward, 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.
on a stock market
by individuals and firms in anticipation of income from dividend
s and capital gain
s, as the value of the stock rises. It may also refer to the acquisition of equity (ownership) participation in a private (unlisted) 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 fund
s 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 portfolio
s have what are called segregated fund
s, 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.
s of the enterprise after deducting all its liabilities. It appears on the balance sheet
/ statement of financial position, one of the four primary financial statement
s.
Ownership equity includes both tangible and intangible items (such as brand names and reputation / goodwill).
Accounts listed under ownership equity include (example):
of equity will change in the case of the following events:
Equities, also known as securities are shares of companies traded in the stock exchanges. Investing in equities can help you attain your investment goals faster considering that most conventional investments like fixed deposits, PPF, bonds etc. often yield a lesser interest rate. However, the investment needs to be done cautiously since market conditions may be volatile and it takes great knowledge & skills to spot market opportunities.
s, 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 / decrease in the value of his own personal share of the equity. This reconciliation of equity should be done both in total and on a per share basis.
, 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.
. This equity is a property right valued at the difference between the market price of the property and the amount of any mortgage or other encumbrance.
Accountancy
Accountancy is the process of communicating financial information about a business entity to users such as shareholders and managers. The communication is generally in the form of financial statements that show in money terms the economic resources under the control of management; the art lies in...
and finance
Finance
"Finance" is often defined simply as the management of money or “funds” management Modern finance, however, is a family of business activity that includes the origination, marketing, and management of cash and money surrogates through a variety of capital accounts, instruments, and markets created...
, equity is the residual claim or interest of the most junior class of investors in asset
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
s, after all liabilities are paid. If liability exceeds assets, negative equity
Negative equity
Negative equity occurs when the value of an asset used to secure a loan is less than the outstanding balance on the loan. In the United States, assets with negative equity are often referred to as being "underwater", and loans and borrowers with negative equity are said to be "upside down".People...
exists. In an accounting context, Shareholders' equity (or stockholders' equity, shareholders' funds, shareholders' capital or similar terms) represents the remaining interest in assets of a company, spread among individual shareholder
Shareholder
A shareholder or stockholder is an individual or institution that legally owns one or more shares of stock in a public or private corporation. Shareholders own the stock, but not the corporation itself ....
s of common
Common stock
Common stock is a form of corporate equity ownership, a type of security. It is called "common" to distinguish it from preferred stock. In the event of bankruptcy, common stock investors receive their funds after preferred stock holders, bondholders, creditors, etc...
or preferred stock
Preferred stock
Preferred stock, also called preferred shares, preference shares, or simply preferreds, is a special equity security that has properties of both an equity and a debt instrument and is generally considered a hybrid instrument...
.
At the start of a business
Business
A business is an organization engaged in the trade of goods, services, or both to consumers. Businesses are predominant in capitalist economies, where most of them are privately owned and administered to earn profit to increase the wealth of their owners. Businesses may also be not-for-profit...
, owners put some funding into the business to finance operations
Business operations
Business operations are those ongoing recurring activities involved in the running of a business for the purpose of producing value for the stakeholders...
. This creates a liability on the business in the shape of capital
Share capital
Share capital or issued capital or capital stock refers to the portion of a company's equity that has been obtained by trading stock to a shareholder for cash or an equivalent item of capital value...
as the business is a separate entity from its owners. Businesses can be considered, for accounting purposes, sums of liabilities and asset
Asset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
s; this is the accounting equation
Accounting equation
The basic accounting equation' is the foundation for the double-entry bookkeeping system. For each transaction, the total debits equal the total credits.In a corporation, capital represents the stockholders' equity.-In practice:...
. After liabilities have been accounted for the positive remainder is deemed the owner's interest in the business.
This definition is helpful in understanding the liquidation
Liquidation
In law, liquidation is the process by which a company is brought to an end, and the assets and property of the company redistributed. Liquidation is also sometimes referred to as winding-up or dissolution, although dissolution technically refers to the last stage of liquidation...
process in case of bankruptcy
Bankruptcy
Bankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
. At first, all the secured creditor
Creditor
A creditor is a party that has a claim to the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property or service to the second party under the assumption that the second party will return an equivalent property or...
s are paid against proceeds from assets. Afterward, 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
Residual claimant
In economics, the residual claimant is the agent who receives the net income .Residual claimancy is generally required in order for there to be moral hazard, which is a problem typical of information asymmetry. This is specifically the case for the principal–agent problem....
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 stockStock
The capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
on a stock market
Stock market
A stock market or equity market is a public entity for the trading of company stock and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately.The size of the world stock market was estimated at about $36.6 trillion...
by individuals and firms in anticipation of income from dividend
Dividend
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...
s and capital gain
Capital gain
A capital gain is a profit that results from investments into a capital asset, such as stocks, bonds or real estate, which exceeds the purchase price. It is the difference between a higher selling price and a lower purchase price, resulting in a financial gain for the investor...
s, as the value of the stock rises. It may also refer to the acquisition of equity (ownership) participation in a private (unlisted) company or a startup company
Startup company
A startup company or startup is a company with a limited operating history. These companies, generally newly created, are in a phase of development and research for markets...
. When the investment is in infant companies, it is referred to as venture capital
Venture capital
Venture capital is financial capital provided to early-stage, high-potential, high risk, growth startup companies. The venture capital fund makes money by owning equity in the companies it invests in, which usually have a novel technology or business model in high technology industries, such as...
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 fund
Mutual fund
A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors to buy stocks, bonds, short-term money market instruments, and/or other securities.- Overview :...
s or as other forms of collective investment scheme
Collective investment scheme
A collective investment scheme is a way of investing money alongside other investors in order to benefit from the inherent advantages of working as part of a group...
, 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
Schroders
Schroders plc is a British multinational asset management company with over 200 years of experience in the world's financial markets. The company employs 2,905 people worldwide who are operating from 32 offices in 25 different countries around Europe, America, Asia and the Middle East...
, Fidelity Investments
Fidelity Investments
FMR LLC or Fidelity Investments is an American multinational financial services corporation one of the largest mutual fund and financial services groups in the world. It was founded in 1946 and serves North American investors. Fidelity Ventures is its venture capital arm...
or The Vanguard Group
The Vanguard Group
The Vanguard Group is an American investment management company based in Malvern, Pennsylvania, that manages approximately $1.6 trillion in assets. It offers mutual funds and other financial products and services to individual and institutional investors in the United States and abroad. Founder...
. Such holdings allow individual investors to obtain the diversification
Diversification (finance)
In finance, diversification means reducing risk by investing in a variety of assets. If the asset values do not move up and down in perfect synchrony, a diversified portfolio will have less risk than the weighted average risk of its constituent assets, and often less risk than the least risky of...
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 portfolio
Portfolio (finance)
Portfolio is a financial term denoting a collection of investments held by an investment company, hedge fund, financial institution or individual.-Definition:The term portfolio refers to any collection of financial assets such as stocks, bonds and cash...
s have what are called segregated fund
Segregated fund
A Segregated Fund is a type of investment fund administered by Canadian insurance companies in the form of individual, variable life insurance contracts offering certain guarantees to the policyholder such as reimbursement of capital upon death. As required by law, these funds are fully...
s, 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
Dividend
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...
yield of an equity and that of the long-term bond.
Accounting
In financial accounting, equity capital is the owners' interest on the assetAsset
In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset...
s of the enterprise after deducting all its liabilities. It appears on the balance sheet
Balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...
/ statement of financial position, one of the four primary financial statement
Financial statement
A financial statement is a formal record of the financial activities of a business, person, or other entity. In British English—including United Kingdom company law—a financial statement is often referred to as an account, although the term financial statement is also used, particularly by...
s.
Ownership equity includes both tangible and intangible items (such as brand names and reputation / goodwill).
Accounts listed under ownership equity include (example):
- Share capitalShare capitalShare capital or issued capital or capital stock refers to the portion of a company's equity that has been obtained by trading stock to a shareholder for cash or an equivalent item of capital value...
(common stockCommon stockCommon stock is a form of corporate equity ownership, a type of security. It is called "common" to distinguish it from preferred stock. In the event of bankruptcy, common stock investors receive their funds after preferred stock holders, bondholders, creditors, etc...
) - Preferred stockPreferred stockPreferred stock, also called preferred shares, preference shares, or simply preferreds, is a special equity security that has properties of both an equity and a debt instrument and is generally considered a hybrid instrument...
- Capital surplusCapital surplusCapital surplus term that frequently appears as a balance sheet item as a component of shareholders' equity. Capital surplus is used to account for that a firm raises in excess of the par value of the shares ....
- Retained earningsRetained earningsIn accounting, retained earnings refers to the portion of net income which is retained by the corporation rather than distributed to its owners as dividends. Similarly, if the corporation takes a loss, then that loss is retained and called variously retained losses, accumulated losses or...
- Treasury stockTreasury stockA treasury stock or reacquired stock is stock which is bought back by the issuing company, reducing the amount of outstanding stock on the open market ....
- Stock options
- ReserveReserve (Accounting)In financial accounting, the term reserve is most commonly used to describe any part of shareholders' equity, except for basic share capital. Sometimes, the term is used instead of the term provision; such a use, however, is inconsistent with the terminology suggested by International Accounting...
Book value
The book valueBook value
In accounting, book value or carrying value is the value of an asset according to its balance sheet account balance. For assets, the value is based on the original cost of the asset less any depreciation, amortization or Impairment costs made against the asset. Traditionally, a company's 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 assets.
- 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 (except for its tax consequences), 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 (increases the size of each share) in future income and distributions.
- Dividends paid out to preferred stockPreferred stockPreferred stock, also called preferred shares, preference shares, or simply preferreds, is a special equity security that has properties of both an equity and a debt instrument and is generally considered a hybrid instrument...
owners are considered an expense to be subtracted from net incomeNet incomeNet income is the residual income of a firm after adding total revenue and gains and subtracting all expenses and losses for the reporting period. Net income can be distributed among holders of common stock as a dividend or held by the firm as an addition to retained earnings...
(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.
Equities, also known as securities are shares of companies traded in the stock exchanges. Investing in equities can help you attain your investment goals faster considering that most conventional investments like fixed deposits, PPF, bonds etc. often yield a lesser interest rate. However, the investment needs to be done cautiously since market conditions may be volatile and it takes great knowledge & skills to spot market opportunities.
Shareholders' equity
When the owners are shareholderShareholder
A shareholder or stockholder is an individual or institution that legally owns one or more shares of stock in a public or private corporation. Shareholders own the stock, but not the corporation itself ....
s, 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
Stock valuation
In financial markets, stock valuation is the method of calculating theoretical values of companies and their stocks. The main use of these methods is to predict future market prices, or more generally potential market prices, and thus to profit from price movement – stocks that are judged...
and accounting.
The individual investor is interested not only in the total changes to equity, but also in the increase / decrease in the value of his own personal share of the equity. This reconciliation of equity should be done both in total and on a per share basis.
- Equity (beginning of year)
- + net income inter net money you gained
- − dividends how much money you gained or lost so far
- +/− gain/loss from changes to the number of shares outstandingShares outstandingShares outstanding are common shares that have been authorized, issued, and purchased by investors. They have voting rights and represent ownership in the corporation by the person or institution that holds the shares. They should be distinguished from treasury shares, which is common stock held by...
. - = Equity (end of year) if you get more money during the year or less or not anything
Market value of shares
In the stock marketStock market
A stock market or equity market is a public entity for the trading of company stock and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately.The size of the world stock market was estimated at about $36.6 trillion...
, 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
Cash flow
Cash flow is the movement of money into or out of a business, project, or financial product. It is usually measured during a specified, finite period of time. Measurement of cash flow can be used for calculating other parameters that give information on a company's value and situation.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 redemptionEquity of redemption
The equity of redemption refers to the right of a mortgagor in law to redeem his property once the liability secured by the mortgage has been discharged.-Overview:...
. This equity is a property right valued at the difference between the market price of the property and the amount of any mortgage or other encumbrance.