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What is Equity: Understanding Its Meaning, Applications, and Significance

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Equity means owning a piece of something valuable, like a company, a house, or even an investment. Going by Equity’s definition, it is owning a part of a company through shares. You can buy equity shares to gain ownership in companies. 

However, it is crucial to know that the market value of your equity can change. For example, if the company in which you own shares starts making profits, the price of your shares might go up, boosting your equity value. If, for any reason, the company experiences a loss, the value of your shares will go down.

Let’s understand equity by an example: Suppose you bought a house on loan. The amount you owe on your home loan is your debt; the difference between that and the house’s current value is your equity. So, if you owe ₹ 40 lakhs on your home, but it’s worth ₹ 80 lakhs, your equity is ₹ 40 lakhs.

Key Takeaways

  • Ownership Stake: Equity signifies ownership in a company through shares.
  • Proportional Claim: Shareholders have a proportional claim on the company’s assets and earnings.
  • Market Value: In financial markets, equity reflects the market value of shares, indicating the company’s overall worth.
  • Investor Participation: Investors engage with equity to share a business’s success, earning profits or bearing losses.
  • Portfolio Diversification: Equity plays a crucial role in diversifying investment portfolios.
  • Long-Term Wealth: It is a pathway to long-term wealth creation for investors.

How Is Equity Calculated?

Equity can be calculated using the following basic formula:

Equity = Total Assets – Total Liabilities

This formula represents the accounting equation, where a company’s equity equals its total assets minus its liabilities. In other words, equity is what’s left of a company’s assets once you subtract its liabilities. 

For publicly traded companies, equity can be calculated as:

Equity = Number of Outstanding Shares * Market Price per Share

This equation considers the total outstanding shares and the current market price per share to determine the equity’s market value.

 Formula and How to Calculate Shareholders’ Equity

Shareholders’ equity represents shareholders’ residual claim on the company’s assets after all debts are settled. It shows the net assets that would be available for distribution to shareholders if the company were liquidated.

The formula for calculating shareholders’ equity is quite simple:

Shareholders’ Equity = Total Assets – Total Liabilities

Components of Shareholder Equity 

The key components of shareholder equity are:

  • Share Capital: Money raised by selling shares (common/preferred, with different rights).
  • Retained Earnings: Profits reinvested for growth, not paid out as dividends.
  • Treasury Stock: Repurchased shares, which reduces the total outstanding shares.

Example of Shareholder Equity

Let’s imagine a bustling dhaba called “Masala Magic” on the outskirts of Agra to understand shareholder equity:

Balance Sheet (in lakhs):

Cash (masala stock & utensils)
 ₹ 5 
Stove & cooking equipment₹ 10
Tables & chairs₹ 2
Total Assets₹ 17

Liabilities:

Loan for initial setup₹ 8
Supplier dues for spices₹ 1
Total liabilities₹ 9

Now, using the formula:

  • Shareholder Equity = Total Assets – Total Liabilities
  • Shareholder Equity = ₹17 – ₹9
  • Shareholder Equity = ₹8

In this example, the owners of Masala Magic (shareholders) claim ₹8 lakhs on the dhaba’s assets after all debts are paid. This means they own about 47% (equity / total assets) of the business.

Breakdown of components:

  • Share Capital: Let’s say the owners invested ₹4 lakhs to set up the dhaba. This forms the share capital.
  • Retained Earnings: Over time, Masala Magic made a profit of ₹4 lakhs. They decided to keep some of this for future expansion (₹2 lakhs), which becomes retained earnings. So, total retained earnings are ₹2 lakhs.

Remember:  This is a simplified example. Shareholder equity can be much more complex in real-world companies with various share types, preferred stock dividends, and other factors.

Check Out: JYOTI CNC IPO

Other Forms of Equity

Beyond company shares, various other forms of equity represent ownership or claim to something valuable:

  • Real Estate Equity: Owning a house, apartment, or land gives you equity in that property. Its value can rise or fall based on market conditions and renovations.
  • Private Equity: Investments in non-publicly traded companies. Investors become partial owners with the potential for higher returns or risks.
  • Intellectual Property Equity: Owning patents, copyrights, or trademarks gives you exclusive rights and potential royalties.
  • Sweat Equity: Contributing skills, time, and effort towards a venture, often rewarded with an ownership stake.
  • Cryptocurrency Equity: Owning digital tokens in blockchain projects can represent partial ownership or voting rights within the system.

What Is Equity in Finance?

Equity in finance refers to ownership in a company. Once you subtract your debts, the leftover interest is usually kept as shares. Equity provides a claim on assets and earnings, allowing investors to share in a company’s success and potential profits.

Types of Private Equity Financing

The private equity landscape offers a variety of financing options that address the different needs of companies at different stages of their growth journey. Here are some key types of private equity financing:

  • Venture Capital: Supports high-growth startups, especially in IT, healthcare, and consumer sectors, focusing on seed funding, Series A & B rounds.
  • Angel Investors: Wealthy individuals invest in early-stage ventures, providing capital, mentorship, and guidance.
  • Growth Equity: Fuels mid-stage companies with established track records and proven business models, aiming to accelerate growth through expansion, acquisitions, or IPO preparation.
  • Private Debt: Offers flexible financing solutions to mid-stage companies, often with higher interest rates than traditional bank loans.
  • Buyout Funds (Buyout & Special Situations): Acquire a controlling stake in mature, profitable companies, intending to improve operations and exit through M&As or IPOs.
  • Distressed Debt (Buyout & Special Situations): Invests in financially troubled firms, either restructuring their debt or acquiring them at a discount.
  • Special Situations (Buyout & Special Situations): Focuses on unique opportunities in diverse sectors, such as turnarounds, infrastructure projects, or real estate investments. 

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Home Equity 

Home equity is what’s left of a homeowner’s property value after subtracting the remaining debt. The simple formula is Home Equity = Total property value  – Outstanding balance.

This measure reflects ownership, with higher home equity meaning a more significant stake in the property. Home equity is crucial as collateral for loans, allowing homeowners to borrow against their property’s value.

Equity vs. Return on Equity

Equity and Return on Equity (RoE) are related financial terms but differ in meaning. Equity is the ownership value in a company, reflecting the residual interest after deducting liabilities. While equity signifies ownership, RoE identifies how efficiently a company generates profits with the equity it has. In simple terms, equity is ownership, and RoE checks how well a company uses that ownership to make profits for shareholders.

 What Are Some Other Terms Used to Describe Equity?

Terms like ownership, stock, shares, or stake in a company are also used to describe equity. It can also be referred to as net assets, residual interest, or shareholder’s equity. These terms convey the concept of having a financial interest in a business and sharing its assets and profits.

How do Investors use Equity?

Investors use equity by buying company shares, granting them ownership and a profit share. This brings the potential for capital growth and dividends. Equity also helps diversify portfolios and create long-term wealth. It acts as collateral, allowing investors to engage in financial markets and make strategic investment choices.

Read More: Grey Market Premium

FAQs

  1. What is an equity fund?

    Equity funds are a popular investment option that allows you to collect all your resources. These funds are put into various stocks, giving you ownership in different companies. Equity is a crucial tool for you to join and gain from the success of businesses.

  2.  What is private equity?

    Private equity means putting money into companies not yet traded on stock exchanges. This could be startups, small businesses, or buying big companies and making them private. Investors give their money to professionals who manage private equity funds. These professionals pick and invest in promising companies. So, private equity is like a way for investors to support and maybe make money from the growth of companies that are not on the stock market yet.

  3.  What is brand equity?

    Brand equity is the extra value a brand brings to a product, extending beyond the physical item to include consumer perceptions, loyalty, and trust. A strong brand with positive associations can charge more and become the preferred choice. It's essentially the brand's reputation—whether people trust it, like it, and choose it over others.

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I’m Archana R. Chettiar, an experienced content creator with
an affinity for writing on personal finance and other financial content. I
love to write on equity investing, retirement, managing money, and more.

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