Equity vs. Capital: What's the Difference?
Equity and capital are terms used to describe the monetary interest owners or shareholders have in a business through funds, assets or shares. While equity and capital have some similarities, there are key differences between these two terms that are important for successful business owners to know to ensure financial success for their companies. Whether you work in investment banking, private equity or another sector of the financial industry, you can benefit from knowing the difference between equity and capital. In this article, we define what equity and capital mean, discuss why they are important and share how you can use equity and capital to determine the financial health of your company.
What is equity?
Equity is an owner's share of the assets of a business. Also referred to as owner's equity or shareholder's equity, it represents the amount of money a business owner or shareholder would receive if they liquidated all their assets and paid off the company's debt. Equity can also help you assess the overall value of a business. Analysts often include equity on a company's balance sheet to determine the overall financial health of a business.
To calculate equity, use the following formula:
Equity = total assets - total liabilities
Why is equity important?
Equity is important because it helps determine whether a company is financially stable. If a company has positive equity, it has enough assets to cover its liabilities. However, if a company has negative equity, it does not have enough assets to cover its liabilities.
Equity can also determine how much each individual share of a company is worth. This helps shareholders decide whether they should invest in a company.
What factors impact equity?
Changes in a company's assets or liabilities, including gains and losses from operations or investments, accounting changes, the payout of cash dividends and other transactions, can affect equity.
A few common items that impact a company's equity are:
Retained earnings: This refers to any earnings a company accumulates after it pays shareholder dividends. Retained earnings are a portion of a company's net income, which it typically uses for investments, and can have a positive impact on a company's equity.
Treasury shares: If your company buys shares back from shareholders, you use treasury shares to account for the amount paid. This can have a negative impact on a company's equity.
Net income: A company's net income refers to its total revenue after paying all expenses. When a company's total revenue is greater than its total expenses, the leftover net income positively impacts its equity.
Dividend payments: When a company rewards shareholders with a cash dividend, it deducts the transaction from the company's available capital. This can decrease the company's retained earnings and its equity.
Types of equity
Here are two common types of equity used by businesses:
Owner's equity refers to the company owner's control in the company. Sole proprietors and business partners commonly use this type of equity. Owner's equity can highlight how much available capital a business has.
Read more: Owner's Equity: Definition and Examples
Shareholder's equity, also called stockholder's equity, refers to the number of assets shareholders have in a company after deducting all liabilities. Businesses structured as corporations often use this type of equity. Shareholder's equity can show you how much money is available for shareholder distribution.
What is capital?
Capital refers to a company's financial assets, such as funds available in a business bank account or through a business loan. Instead of focusing on the overall value of a company as equity does, capital focuses on the financial resources available to conduct daily business operations, such as covering payroll and producing products or services.
Why is capital important?
Capital is important because it represents a company's available funding and determines whether a company can pay for the ongoing production of its products and services. A company typically requires adequate capital to generate profit and foster growth. For example, a business can use its available capital to expand, hire new employees or upgrade its technology to produce better products.
What factors influence capital?
There are several factors that can influence capital, such as the assets a business currently has available and its liabilities.
Assets that can positively influence capital include:
Cash currently available to the business
Short-term accounts receivable
Funding available through loans or a business's bank accounts
Liabilities that can negatively influence capital include:
Money owed to vendors
Types of capital
Here is an overview of the four main types of business capital:
A company's working capital accounts for all available cash and liquid assets used to cover daily operations and accounts payable. To calculate working capital, use the following formula:
Working capital = accounts receivable + inventory - accounts payable
The resulting value in this calculation is the working capital a company currently has available. Financial professionals use this to determine whether a company has the ability to pay for any upcoming debts, accounts payable or other short-term obligations.
Trading capital refers to the amount of money a company or individual allocates to buying and selling securities. All securities markets have a legal minimum amount of trading capital set before a company can start trading. Markets establish this to ensure that a company can cover any potential losses.
A business can gain debt capital by borrowing money from a bank or government institution. Smaller businesses may also obtain debt capital by borrowing money from family and friends, credit card companies, online lenders or federal loan programs.
Businesses can receive equity capital in several forms, including private and public equity. A business can raise both private and public equity by selling shares of stock in a company. Private equity is typically raised by a group of closed investors, while public equity is raised by listing a company's shares on a stock exchange.
Equity vs. capital
Here are some key differences between equity and capital:
Equity represents the total amount of money a business owner or shareholder would receive if they liquidated all their assets and paid off the company's debt. Capital refers only to a company's financial assets that are available to spend.
Business owners use equity to assess the overall value of their business, while capital focuses only on the financial resources currently available.
Equity helps determine whether a company is financially stable long term, while capital determines whether a company can pay for the short-term production of products and services.
Capital is a subcategory of equity, which includes other assets such as treasury shares and property.
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