What is Equity?5 min readReading Time: 4 minutes
If you are a new investor who is just stepping into the field of investment, equity is one of the first few words that you will be constantly bombarded with.
It is also a very important term that you as a newbie should understand as a lot will be dependent on your understanding going forward.
Equity at the same time also means stocks or shares. Stocks are the type of equity that represents equity investment. Stocks and equity are the same, as both represent the ownership of an entity and are traded on the stock exchanges.
Simplified Meaning of Equity
To break it down in an easy format for you, equity is the amount of capital that you invest or the amount which is owned by the owner or owners of a company.
The correct form of evaluating an Equity is by differentiating between liabilities and assets which have been recorded on the balance sheet of a company. Equity is based on the current share price or a value regulated by valuation professionals or investors. This account is also known as owners or stockholders or shareholders equity.
When investors invest in a company or an industry’s equities they, become its partial owners.
Equity makes an important component in a company’s balance sheet. It is also one of the most common pieces of data accessed by analysts, researchers to announce the financial health of a company.
Formula to Calculate Shareholder Equity
The formula and calculation given below can be used to determine the equity of a company which is derived from the accounting equation-
Shareholders’ Equity = Total Assets −Total Liabilities
Types of Equity
Anyone who makes an investment in equity shares or monitors the functioning of the company must know about the various types of equity shares. The equity shares are presented on the liability side of the balance sheet and they are classified in the following types.
Authorised Share Capital
As the name suggests, authorised capital is the maximum amount of capital that a company can issue. The authorised limit can be increased after seeking permission from the respective authorities to pay fees.
Issued Share Capital
Out of the authorised share capital, the capital the company offers to investors is termed as issued share capital.
Subscribed Share Capital
Subscribed capital is part of the issued share capital that investors agree to and accept.
Paid Up Capital
Paid up capital is part of the subscribed capital for which the investors pay. In general, the companies issue the shares to the investors after collecting all the money in one go. Therefore, it is not wrong to say that subscribed and paid-up capital is the same thing where the company collects all the money and issues shares. However, conceptually the paid-up capital is the amount of capital that the company invests in the business.
When you make an investment in equity shares and the company issues further shares to you, it is termed as the right shares. The right shares are issued to protect the ownership of existing investors.
Bonus shares are issued by the company to its investors in the form of a dividend.
Sweat Equity Shares
When employees or directors perform their job well in terms of providing know-how or intellectual property rights to the company, the company issues sweat equity shares to them as a reward.
Advantages of Equity
There are several advantages that an investor can enjoy by investing in equity shares. We have listed a few of them for you.
Investing in shares/equity can be an easy process. Investors can avail these services of through a stockbroker or financial planner to invest through various stock exchanges in a country. If an individual has set up a Demat account, he/she can buy the stocks in a few minutes. So, irrespective of whether an investor chooses to invest via NSE or BSE equity or the like, he/she can enjoy the ease of investment.
Investing in equity shares can bring along high returns for investors. Shareholders have an opportunity for wealth creation, not just through dividend earnings but also through capital appreciation.
Shield from inflation
When a person begins to invest in equity shares, he eventually builds up the potential to get relatively high returns. The rate of returns that he ends up getting is often more than the rate of wearing down of the investor’s purchasing power due to inflation. Hence investing in equity shares can prove to be a hedge against inflation.
Disadvantages of Investing in Equity
While investors do get to enjoy a sweet share of profit by investing in equities, one needs to learn that it may also involve some sorts of risks or disadvantages.
It could be a risky affair
Investing in equity shares may bring you good returns on some days, but it also exposes investors to high risk as compared to other investment options like debt instruments. An investor can risk losing his/her entire investment corpus by investing in equity shares.
Impact of Socio-political changes
The on-going social and political issues in a country can disrupt the way a business works. For example, if a government decides to promote indigenous businesses, it might restrict the entry of foreign business into the country. If investors have invested in home-grown businesses, they in this situation will benefit from better performance of his/her investments.
Equity overall reflects the value that would be returned to a company’s shareholders or investors if all of the assets were to be liquidated and all of the company’s debts were paid off. It also represents the shareholders’ stake in the company, identified on the company’s balance sheet.