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In accounting and finance, equity is the residual claimant 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.
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 proxy statement received by the investor) as well as certain major transactions, and residual rights, meaning that they share the company's profits, as well as recover some of the company's assets in the event that it folds, although they generally have the lowest priority in recovering their investment. It may also refer to the acquisition of equity (ownership) participation in a private (unlisted) company or a startup company. When the investment is in infant companies, it is referred to as venture capital investing and is generally regarded as a higher risk than investment in listed going-concern situations.
The equities held by private individuals are often held as mutual funds or as other forms of collective investment scheme, 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, such as 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, 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.
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. 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:
The book value of equity will change in the case of the following events:
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.
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 statements.
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 price of the property and the amount of any mortgage or other encumbrance.