Definition of Equity:
Equity refers to the ownership interest or residual claim that the owners or shareholders have in a company after deducting the liabilities. It represents the net assets or value of a business, which is spread among the owners proportionally in terms of their ownership percentage.
Characteristics of Equity:
- Ownership: Equity represents the ownership stake or shareholding in a company.
- Residual claim: Owners of equity have a residual claim on the assets and earnings of a company after all the liabilities have been settled.
- Value: Equity represents the value of a business, and its fluctuations directly impact the shareholders’ wealth.
- Long-term capital: Equity is considered a long-term source of capital for a company as it does not require regular repayment like debt.
- Risk and return: The ownership of equity involves the trade-off between risk and return. Shareholders bear the risk of potential losses but also have the opportunity to benefit from higher returns.
Types of Equity:
There are various types of equity, including:
- Common Equity: It represents the ownership interest of common shareholders in a company and provides them voting rights and the right to receive dividends.
- Preferred Equity: Preferred shareholders have a higher claim on the company’s assets and earnings compared to common shareholders. They usually receive fixed dividends and have limited voting rights.
- Retained Earnings: Retained earnings are the portion of a company’s profits that are not distributed as dividends but retained for reinvestment or debt reduction. The retained earnings contribute to the equity of the business.
Equity is an essential component for determining a company’s financial health, valuation, and attractiveness to investors.