Equity (finance)

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In accounting, equity (or owner's equity) is

the difference between the value of the
assets and the value of the liabilities of
something owned. It is governed by the
following equation:

For example, if someone owns a car worth

$15,000 (an asset), but owes $5,000 on a
loan against that car (a liability), the car
represents $10,000 of equity. Equity can
be negative if liabilities exceed assets.
Shareholders' equity (or stockholders'
equity, shareholders' funds, shareholders'
capital or similar terms) represents the
equity of a company as divided among
shareholders of common or preferred
stock. Negative shareholders' equity is
often referred to as a shareholders' deficit.

Alternatively, equity can also refer to the

capital stock of a corporation. The value of
the stock depends on the corporation's
future economic prospects. For a
company in liquidation proceedings, the
equity is that which remains after all
liabilities have been paid.

Owner's equity
When starting a business, the owners fund
the business to finance various
operations. Under the model of a private
limited company, the business and its
owners are separate entities, so the
business is considered to owe these funds
to its owners as a liability in the form of
share capital. Throughout the business's
existence, the equity of the business will
be the difference between its assets and
debt liabilities; this is the accounting
equation.

When a business liquidates during

bankruptcy, the proceeds from the assets
are used to reimburse creditors. The
creditors are ranked by priority, with
secured creditors being paid first, other
creditors being paid next, and owners
being paid last. Owner's equity (also
known as risk capital or liable capital) is
this remaining or residual claim against
assets, which is paid only after all other
creditors are paid. In such cases where
even creditors could not get enough
money to pay their bills, the owner's equity
is reduced to zero because nothing is left
to reimburse it.

Accounting
In financial accounting, owner's equity
consists of the net assets of an entity. Net
assets is the difference between the total
assets and total liabilities.[1] Equity
appears on the balance sheet (also known
as the statement of financial position), one
of the four primary financial statements.

The assets of an entity can be both

tangible and intangible items. Intangible
assets include items such as brand
names, copyrights or goodwill. Tangible
assets include land, equipment, and cash.
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
The book value of equity will change in the
case of the following events:

Changes in assets relative to 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,
increases its retained earnings,
therefore its shareholders' equity.
Issue of new equity in which the firm
obtains new capital increases the total
shareholders' equity.
Share repurchases, in which a firm
returns money to 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. Rather than giving money to
all shareholders immediately in the form
of a dividend payment, a share
repurchase reduces the number of
shares outstanding.
Dividends paid out to preferred stock
owners are considered an expense to be
subtracted from net income(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

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 analysis for both stock
valuation and accounting.

Shareholders' equity is obtained by

subtracting total liabilities from the total
assets of the shareholders.[3] These
assets and liabilities can be:

Equity (beginning of year)

+ net income
 − dividends
+/− 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

Equity stock
Equity investments

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. 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.

Market value of equity stock

In the stock market, market price per share

does not correspond to the equity per
share calculated in the accounting
statements. Equity 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. While
accounting equity can potentially be
negative, market price per share is never
negative since equity shares represent
ownership in limited liability companies.
The principle of limited liability guarantees
that a shareholder's losses may never
exceed his investment.

Merton model

In the Merton model, the value of stock

equity is modeled as a call option on the
value of the whole company (including the
liabilities), struck at the nominal value of
the liabilities.[4]
In this model, the equity market value
depends on the volatility of the market
value of the company assets.

Equity in real estate

The notion of equity as it relates to real
estate derives from the concept called
equity of redemption. This equity is a
property right valued at the difference
between the market value of the property
and the amount of any mortgage or other
encumbrance.

See also
Art equity
 Private equity

References
1. IFRS Framework quotation: International
Accounting Standards Board F.49(c)
2. Example of Balance Sheet
3. Hervé Stolowy; Michel Lebas (January
2006). Financial Accounting and Reporting:
A Global Perspective . Cengage Learning
EMEA. p. 42. ISBN 1-84480-250-7.
4. Merton, Robert C. (1974). "On the Pricing
of Corporate Debt: The Risk Structure of
Interest Rates". Journal of Finance. 29 (2):
449–470. doi:10.1111/j.1540-
6261.1974.tb03058.x .
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