Equity

Equity Meaning

Equity in Finance refers to investors ownership in a company and represents the amount that they would receive after the liquidation of assets and paying off the liabilities such as debt. It is calculated as the difference between the assets and liabilities shown on the balance sheet of a company.

Explanation

Equity-Formula

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Source: Equity (wallstreetmojo.com)

When an investor invests in the share of any company, such an investor becomes an owner of the company’s net assetsNet AssetsThe net asset on the balance sheet is the amount by which your total assets exceed your total liabilities and is calculated by simply adding what you own (assets) and subtract it from whatever you owe (liabilities). It is commonly known as net worth (NW).read more in proportion to the shares held by such an investor.  The formula to calculate equity is given below –

Equity = Assets – Liabilities

Equity includes the share capitalShare CapitalShare capital refers to the funds raised by an organization by issuing the company's initial public offerings, common shares or preference stocks to the public. It appears as the owner's or shareholders' equity on the corporate balance sheet's liability side.read more, profit and loss balance, other comprehensive incomeOther Comprehensive IncomeOther comprehensive income refers to income, expenses, revenue, or loss not being realized while preparing the company's financial statements during an accounting period. Thus, it is excluded and shown after the net income.read more, as well as any reserves or surplusReserves Or SurplusReserves and Surplus is the amount kept aside from the profits that are to be used either for the business or for the shareholders to pay out dividends. Reserves and surplus is reflected under shareholders funds in the balance sheet.read more.

Equity shareholders earn profit from capital gains and capital appreciationCapital AppreciationCapital appreciation refers to an increase in the market value of assets relative to their purchase price over a specified time period. Stocks, land, buildings, fixed assets, and other types of owned property are examples of assets.read more due to an increase in stock prices. They also get the right to vote in the important decisions of the company. However, there is a certain risk in investing in shares.

Characteristics

How does it Work?

When an individual or any other investor invests in the share of a company, they become equity shareholder, and they gain ownership in the company’s net assets to the extent of shares held by them. The shares don’t have any repayment date, and it is only upon liquidation that the equity shareholders get repaid to the extent of residual resources available. The shareholders can transfer their shares, and the person to whom these shares are transferred becomes the new equity holder for such proportionate holding.

In the balance sheet of a company, it can change due to several factors such as the change in the realized and unrealized profits, issue of fresh share capital, buyback of existing share capital, dividend declaration, and so on.

Example of Equity

Suppose a company ABC Ltd. is engaged in the manufacturing of textiles. Annual Report for the year ending on 31 March’19 was published. Following are the details of the Balance Sheet. Let us calculate the equity of ABC Ltd. as on 31 March’19 with the information provided below-

Equity Example 1

Solution

Calculation of equity is as follows –

Equity Example 1.1
  • = $51,500,000 – $11,000,000
  • = $40,500,000

Market Value of Equity

In the case of publicly tradedPublicly TradedPublicly Traded Companies, also called Publicly Listed Companies, are the Companies which list their shares on the public stock exchange allowing the trading of shares to the common public. It means that anybody can sell or buy these companies’ shares from the open market.read more common stock, the market value of equity or market capitalization is calculated as multiple of the number of shares outstanding and the company’s current stock price. Its market value can be construed as the company’s value as seen by the market, i.e. investors.

Example: As on date, a company has 250 million shares outstanding, which are trading for $65 per share. In this case, the market value of equity can be calculated as follows:

Market Capitalization = No. of Equity Shares Outstanding * Current Market Price per Share

Market Capitalization = 250 million * $65 = $16,250 million

Why is Equity Important?

Equity is not only beneficial for the investor but also the issuing company. For the investor, it helps in earning a high rate of return on their investment through capital gain and getting the proportionate ownership of that company. For the issuing company, equity helps get the required amount of capital to start or continue their business as the required capital is divided into small portions that are then purchased by the investor.

Advantages

Disadvantages

Important Point

Equity is very important for the investor as it shows the value attributable to them in the company. Equity ownership makes them the owner of the company’s net assets. It also enables the shareholder to enjoy the right to vote and attend the meetings related to the company’s affairs. This increases the interest of shareholders towards the company.

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This has been a guide to Equity and its meaning. Here we discuss how it works, characteristics, examples and its importance. You can learn more from the following articles –