Equity (finance)

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 (or stockholders' equity, shareholders' funds,
shareholders' capital or similar terms) 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.

Contents
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1 Equity investments
2 Accounting
o 2.1 Book value
3 Shareholders' equity
4 Market value of shares
5 Equity in real estate
6 See also
7 References

Equity investments[edit]
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 (shown on a 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[edit]
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.[1] 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 (common stock)

Preferred stock
Capital surplus
Retained earnings
Treasury stock
Stock options
Reserve[2]

Book value[edit]
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 (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.

Shareholders' equity[edit]
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 (beginning of year)

+ 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 (end of year) if one gets more money during the year or less or not anything

Market value of shares[edit]

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 statement.

Equity in real estate[edit]

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 market of the property and the amount of any
mortgage or other encumbrance.