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Ownership equity
From Wikipedia, the free encyclopedia
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At the start of a business, owners put some funding into the business to finance assets. Businesses can be considered for accounting purposes to be sums of liabilities and assets; this is the accounting equation. After liabilities have been accounted for, the positive remainder is deemed the owner's interest in the business. Thus, in accounting terms, [ownership equity][1] is the remaining interest in all assets after all liabilities are paid. If valuations placed on assets do not exceed liabilities, negative equity exists.
This definition is helpful when a business is not paying its bills and gets liquidated, wound up, put into receivership or bankruptcy. Then, a series of creditors, ranked in priority sequence, have the first claim on the proceeds (e.g. asset sales), and ownership equity is the last or residual claim against assets, paid only after all other creditors are paid. In such a case, creditors may not get enough money to pay their bills, and nothing is left over to reimburse owners' equity. Thus owners' equity is reduced to zero. Ownership equity is also known as risk capital, liable capital and equity.
When the owners are shareholders, the interest can be called shareholders' equity;[2] the accounting remains the same, although 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.
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Equity capital is defined as the amount of capital provided by the company's owner(s). Providing new equity (an "issuance" of new equity) gives the firm new capital and increases owners' equity by the same amount and time needed. An issuance of new shares, to raise new capital, increases shareholders' equity. Formally, owners' equity is also a form of liability, but is deemed separate and different from other liabilities since it is a residual interest, ranked last in the series; equity is generally considered to be an asset.
In the stock market, market price per share does not correspond to the equity per share calculated in the accounting statements. Stock valuations, often much higher, are based on other considerations related to the business' operating cashflow, profits and future prospects; some factors are derived from the accounting statements. Thus, there is little or no correlation between the equity seen in financial statements and the stock valuation of the business.
Individuals can also use market valuations to calculate equity in real estate. An owner refers to his or her equity in a property as the difference between the market price of a property and the liability attached to the property (mortgage or home equity loan). This is the exact opposite of how equity is considered for accounting purposes.