Equity (finance)
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| Accountancy | |
|---|---|
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| Key concepts | |
| Accountant · Bookkeeping · Trial balance · General ledger · Debits and credits · Cost of goods sold · Double-entry system · Standard practices · Cash and accrual basis · GAAP / IFRS | |
| Financial statements | |
| Balance sheet · Income statement · Cash flow statement · Equity · Retained earnings | |
| Auditing | |
| Financial audit · GAAS · Internal audit · Sarbanes–Oxley Act · Big Four auditors | |
| Fields of accounting | |
| Cost · Financial · Forensic · Fund · Management · Tax | |
In accounting and finance, equity is the residual claim or interest of the most junior class of investors in an assets, after all liabilities are paid. If valuations placed on assets do not exceed liabilities, 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 shareholders of common or preferred stock.
At the start of a business, owners put some funding into the business to finance assets. This creates liability on the business in the shape of capital as business is a separate entity from its owners. Businesses can be considered to be, 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 owner's interest in the business.
This definition is helpful to understand 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[1]. In such cases where even creditors could not get enough money to pay their bills, and nothing is left over to reimburse owners' equity. Thus owners' equity is reduced to zero. Ownership equity is also known as risk capital, liable capital and equity.
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[edit] Equity investments
Equity investments 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 gain as the value of the stock rises. It also sometimes refers to the acquisition of equity (ownership) participation in a private (unlisted) company or a startup (a company being created or newly created). When the investment is in infant companies, it is referred to as venture capital investing and is generally understood to be higher risk than investment in listed going-concern situations.
The equities held by private individuals are often held via mutual funds or other forms of pooled investment vehicle, 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 (e.g. 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, 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 e.g. mutual fund alternative.
[edit] Accounting
In financial accounting, it is the owners' interest on the assets of the enterprise after deducting all its liabilities.[2] It appears on the balance sheet / Statement of Financial Position[3], one of the four primary financial statements.
Ownership equity includes both tangible and intangible items (such as brand names and reputation / goodwill).
Accounts listed under ownership equity include (example):
- Preferred stock
- Share capital, common stock
- Capital surplus
- Stock options
- Retained earnings
- Treasury stock
- Reserve (accounting)
[edit] 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 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 stock owners are considered an expense to be subtracted from net income[citation needed](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.
[edit]
When the owners are shareholders, the interest can be called shareholders' equity;[4] 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.
- Equity (beg. 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 outstanding.more or less
- = Equity (end of year) if you get more money during the year or less or not anything
[edit]
In the stock market, market price per share does not correspond to the equity per share calculated in the accounting statements. Stock valuations, often much higher, are based on other considerations related to the business' operating cashflow, profits and future prospects; some factors are derived from the accounting statements. Thus, there is little or no correlation between the equity seen in financial statements and the stock valuation of the business.
[edit] Real estate equity
Individuals can also use market valuations to calculate equity in real estate. An owner refers to his or her equity in a property as the difference between the market price of a property and the liability attached to the property (mortgage or home equity loan).
[edit] References
- ^ www.oopine.com
- ^ IFRS Framework quotation: International Accounting Standards Board F.49(c)
- ^ Financial statements
- ^ shareholders' equity Definition
- Chapter 12 of The General Theory of Employment Interest and Money, by John Maynard Keynes (Author), 1936.
- Yes, You Can Time the Market!, by Ben Stein (Author), Phil DeMuth (Author), John Wiley & Sons, 2003, hardcover, 240 pages, ISBN 0-471-43016-1
- The Profit Magic of Stock Transaction Timing, J.M.Hurst (Author), Prentice-Hall, 1970.
- Security Analysis: Principles and Techniques (Second Edition), Benjamin Graham and David Dodd (Authors); (a classic study of how to analyse companies prior to investment).
