Dr Keen Mhlanga
Equity, typically referred to as shareholder’ equity (or owners’ equity for privately held companies), represents the amount of money that would be returned to a company’s shareholders if all of the assets were liquidated and all of the company’s debt was paid off in the case of liquidation.
In the case of acquisition, it is the value of company sales minus any liabilities owed by the company not transferred with the sale.
Equity represents the shareholders’ stake in the company, identified on a company’s balance sheet. The calculation of equity is a company’s total assets minus its total liabilities, and it’s used in several key financial ratios such as ROE (Return on equity).
Equity can be found on a company’s balance sheet and is one of the most common pieces of data employed by analysts to assess a company’s financial health.
In addition, shareholder equity can represent the book value of a company. Equity can sometimes be offered as payment-in-kind. It also represents the pro-rata ownership of a company’s shares.
By comparing concrete numbers reflecting everything the company owns and everything it owes, the “assets-minus-liabilities” shareholder equity equation paints a clear picture of a company’s finances, easily interpreted by investors and analysts.
Equity is used as capital raised by a company, which is then used to purchase assets, invest in projects, and fund operations. A firm typically can raise capital by issuing debt (in the form of a loan or via bonds) or equity (by selling stock).
Investors usually seek out equity investments as it provides a greater opportunity to share in the profits and growth of a firm.
Equity is important because it represents the value of an investor’s stake in a company, represented by the proportion of its shares.
Owning stock in a company gives shareholders the potential for capital gains and dividends.
Owning equity will also give shareholders the right to vote on corporate actions and elections for the board of directors. These equity ownership benefits promote shareholders’ ongoing interest in the company.
Shareholder equity can be either negative or positive. If positive, the company has enough assets to cover its liabilities. If negative, the company’s liabilities exceed its assets; if prolonged, this is considered balance sheet insolvency.
Typically, investors view companies with negative shareholder equity as risky or unsafe investments.
Shareholder equity alone is not a definitive indicator of a company’s financial health; used in conjunction with other tools and metrics, the investor can accurately analyse the health of an organisation.
The concept of equity has applications beyond just evaluating companies. We can more generally think of equity as a degree of ownership in any asset after subtracting all debts associated with that asset. There are other types of equity as private, home and brand equity.
Private equity generally refers to such an evaluation of companies that are not publicly traded. The accounting equation still applies where stated equity on the balance sheet is what is left over when subtracting liabilities from assets, arriving at an estimate of book value.
Privately held companies can then seek investors by selling off shares directly in private placements.
These private equity investors can include institutions like pension funds, university endowments, insurance companies, or accredited individuals.
Home equity is roughly comparable to the value contained in home ownership. The amount of equity one has in their residence represents how much of the home they own outright by subtracting from the mortgage debt owed.
Equity on a property or home stems from payments made against a mortgage, including a down payment and increases in property value. When determining an asset’s equity, particularly for larger corporations, it is important to note these assets may include both tangible assets, like property, and intangible assets, like the company’s reputation and brand identity.
Through years of advertising and the development of a customer base, a company’s brand can come to have an inherent value. Some call this value “rand equity,” which measures the value of a brand relative to a generic or store-brand version of a product.
For a business owner, equity is the net value of her investment in the business. This is simple enough, and it is obviously an important matter for any entrepreneur.
There are other reasons why the equity in a business is important. When there are multiple owners, the proportion each investor owns is a key determinant of her influence on business decisions.
The ability to use equity financing can make the difference between growth, stagnation and even failure of the company.
Entrepreneurs are often driven to create new ventures by a passion for a particular industry, but the underlying purpose of a business is to provide income and, for many, to serve as an investment that can be sold to make a profit.
Equity is an important concept in business and personal finance, which describes the ownership interest that a person has in an asset.
Owner’s equity describes the total amount of equity that a business owner has in his company.
In corporations owned by shareholders, owner’s equity is called shareholders’ equity. In essence, owner’s equity is the amount of money that would be left over if a business owner decided to sell all of her business assets and pay back all of her creditors.
If an owner’s equity increases over time, she can potentially sell her business for a profit. Besides determining the value of a company, equity is important to businesses because it can be used to finance expansion.
Funding business expansion by selling shares of stock to investors is “equity financing.” When a company sells stock, it sells equity to investors for cash that it can use to fund growth.
Equity financing is a way that companies can gain access to a large amount of cash without having to take on debt. You should know how investors determine the worth of a company in order to understand the importance of equity.
Equity is one method of assessing a firm’s value and is sometimes called the book value because it is the figure that appears on the financial records of a business.
However, book value is an entirely separate metric than market value. Market value or market capitalisation is the amount investors are willing to pay for an ownership share.
Publicly traded companies place great importance on their stock share price, which broadly reflects a corporation’s overall financial health.
As a rule, the higher a stock price is, the rosier a company’s prospects become. Financial analysts evaluate the trajectory of stock prices in order to gauge a company’s general health.
They likewise rely on earning histories, and price-to-earnings (P/E) ratios, which signal whether a company’s share price adequately reflects its earnings.
All of this data aids analysts and investors in determining a company’s long-term viability.
A company’s stock price reflects investor perception of its ability to earn and grow its profits in the future. If shareholders are happy, and the company is doing well, as reflected by its share price, the management would likely remain and receive increases in compensation.