When you want to invest in a company or issuer, there will be many factors to consider, including those related to Equity.
For those who are involved in investing, especially shareholders, Equity is something that must be known.
Equity is the value of ownership of something in a company, usually a share.
Meanwhile, the main aspects of Equity include ownership, sharing of profits, risks and responsibilities, market capitalization, and shareholder rights and privileges.
It should be noted; Equity is closely related to justice and equality. Equity provides fair and equal treatment of company shareholders, including profits.
So, to better understand the meaning, elements, how it works, and how to calculate Equity, see the full review below.
Definition of Equity
The definition of Equity is a measure that represents the rights of the owner or an entity over assets in a company.
Equity in business can be defined as a measure of funds that will be returned to shareholders when the company’s assets are later distributed.
The main aspects of Equity include share ownership in a company and profit sharing for shareholders.
Another aspect is the business risk and responsibility of the shareholders as well as the company’s market capitalization value.
In the business context, Equity is closely related to the principles of fairness and Equity because it includes a fair distribution of benefits and equal opportunities.
Besides that, the concept is also related to equal rights and protection to corporate social responsibility in positively contributing to the environment.
Types of Equity that Need to be Understood
It will be very important to understand what types of Equity exist.
In a business context, this is important because it will provide better knowledge regarding the ownership structure of a company, what are the rights of shareholders, to the dynamics of decisions within it.
Overall, this understanding will be a tool for making better decisions to protect the rights of shareholders.
The following are the types of Equity that need to be understood:
1. Home Equity
The home equity is the house’s value minus the amount owed on the mortgage. Note a mortgage is a statement of debt for the credit given to buy a house.
For example, Mr. A wants to buy a house with a bank credit scheme. In this case, if the amount of money borrowed exceeds the house’s selling price, then the house’s equity value will be negative.
However, if the opposite happens, the meaning is positive. Please note this is important to consider to gain profit when selling or buying it.
2. Equity of Business Owners
Certainly, someone will have initial capital when opening a business to do business. Well, the value of that capital is referred to as the Equity of the business owner.
For information, capital is not included in any calculations, and all types of profits that come from it will only be for the business owner.
3. Shareholder Equity
Almost similar to business owners, then there is shareholder equity. However, the difference is in the dividend value.
In this case, the value of dividends from business owners will be shared with shareholders. The reason is that the dividend is the result of investment from the capital that the business owner issued at the beginning.
4. Equity Financing
The last type on this list is equity financing. This type of Equity will be born when the company successfully runs a business but does not make a profit.
In this case, proof of share ownership of the business will be sold to investors, then the proceeds from the sale will be used for company development.
Elements of Equity in the Company
As mentioned above, Equity is a very important element for a company.
Therefore, the company must record the value of its Equity, including listing its assets and liabilities.
This recording is intended so that the company does not experience losses; in this case, the value of Equity must be greater than the value of liabilities.
Here are some elements of Equity in a company that needs to be known, including:
1. Paid up capital
The elements often found in Equity one of which is paid-up capital.
Note that paid-up capital is the amount of funds the company’s owner injects as a shareholder.
The capital here is categorized into two, namely the total valid share value and the premium or share disagio, namely the difference between the value of the deposit from the shareholder and the total value of the shares.
Agio is if the difference is positive, and temporarily disagio is if the difference is negative.
2. Profits that are not shared
Profits that are not shared are also known to be another element of a company’s Equity.
Usually, this undivided profit is called “retained profit.” This element results from operational net profit, which the shareholders do not withdraw.
In this case, it is the company owners who will decide to divide or choose to withhold these profits.
3. Capital from Revaluation
The next element in Equity is the capital from the reassessment. A company, in practice, will apply a re-calculation process for the value of all the assets they have.
Related to that, if later, during the re-calculation process, there is an adjustment to the value of assets, then the difference will make the company’s balance sheet change.
This, then, is the origin of the capital from the reassessment. Suppose Company C has an asset in the form of a piece of land.
Then, during the reassessment process, the price of the land went up. So, the difference in value that arises from the price increase will later become capital for the revaluation.
4. Capital from Donations
Lastly, there is a further element of Equity on this list, which is in the form of capital from donations obtained from grants.
After the implementation of liabilities, all forms of the added value of assets will become the value of Equity.
This also includes when the company obtains capital from donations. Grant or donation capital is an additional capital that applies when a company adds assets without spending.
How Equity Works
Understanding how Equity works in a business context has many important benefits, including those related to decision-making.
Understanding how equity works is fundamentally important for company owners, shareholders, and management.
With this understanding, the above parties can make the right decisions and protect their interests regarding company ownership.
Here’s how Equity works in various forms that need to be understood, namely:
Usually, investors have Equity in a company in the form of public and preferred shares.
This means that business owners share ownership with investors (shareholders).
Please note if someone has shares in a company that has yet to go public, then the name of the Equity is Private Equity.
2. Financial Balance
The way to see the total Equity of the balance sheet, namely by paying attention to the number of ordinary shares, preferred shares, paid-up capital, and retained earnings.
This Equity is called “shareholders’ equity” because it shows the amount of Equity owned by business owners.
Suppose your business goes bankrupt and has to liquidate, so here, the business owner’s Equity is the amount of funds still available after paying off debts and selling all assets owned.
If the financial condition is not good, there will be no equity left after cashing in.
4. Intangible Equity
When calculating Equity, the assets included are tangible and intangible.
The tangible assets include an inventory of owned facilities and property. On the other hand, examples of intangible assets are the reputation of the company, its brand identity, and intellectual property rights.
How to Calculate Equity
How to calculate Equity is also important to understand because there are several great benefits behind it.
With this understanding, shareholders, in particular, will better know the company’s finances and be able to make more measurable decisions.
This is important for creating effective management and long-term business growth.
The following is the basic formula for calculating a company’s Equity, namely:
Equity = Total Assets – Total Liabilities
To calculate Equity, the steps that need to be taken start from identifying total assets and liabilities to calculating the difference between the two.
The following is an example of a case, namely:
Suppose the size of company A’s assets is $400,000, while the total liabilities of this company are $200,000.
This is how to calculate company A’s Equity, namely:
Equity = $400,000 – $200,000
Equity = $200,000
Therefore, the result is that company A’s Equity is $200,000.
In conclusion, in a business context, Equity is an important part because it becomes ownership rights in a company.
In addition, understanding Equity and the importance of ownership rights in a company will help company owners, investors, and other stakeholders understand the value, financial health, and prospects of a company.
In the end, the things above are very important in making investment decisions, company valuation, and correct financial reporting.
So, now you understand the meaning, elements, how it works, and how to calculate Equity.
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