"What is equity?" is a question often asked when discussing corporate finance. This is one of the most basic and important concepts that managers and investors need to understand. In this article, let'sVindoo Learn about this issue and compare it with the concept of charter capital to better understand the role of equity in business operations.
What is equity?
Equity is the amount or value of assets received by a business from investors, shareholders or joint venture members. This is a long-term source of capital for businesses, does not require interest payments like capital loans and is often used to create resources for businesses to go into business. Total equity will be calculated by subtracting liabilities.
Equity is considered a sustainable and long-term source of funding long business, as well as the basis for determining the value of the business. Each capital contributing member has the right to enjoy the same benefits in managing business activities, profits and accept the consequences in case the business enterprise loses.
If the business goes bankrupt or ceases to operate, the source equity will be used for debt repayment. After repaying the debt, the remainder will be divided among the shareholders in proportion to their initial capital investment.
Owner's equity is the source of capital that helps a business get into business>>>> Learn More About: What is divestment? What should businesses do when capital is degraded?
Composition of equity
Depending on the business model, equity includes many different components:
- Shareholder's capital: Accumulated from the company's shareholders, this amount of capital is clearly stated in the company's charter.
- Operating profit: The remaining profit after tax deduction and not yet distributed to shareholders or joint venture members.
- Enterprise funds: Investment and development funds or reserve funds, formed at a rate not exceeding legal regulations.
- Share premium: Is the capital gain from the issuance compared to the current par value.
- Asset valuation difference: revaluation of fixed assets, inventory, investment real estate,...
- Exchange rate difference: If the company deals in foreign currency, the currency item is denominated in foreign currency, this capital will also be taken into account.
Components of equityAll of these sources of capital play an important role in assessing a company's financial value. However, shareholders' equity and operating profit are the most important sources of capital and account for the highest proportion of the enterprise's equity. As shareholders further invest in the business, the equity of the business will increase significantly.
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Current forms of equity
Currently, there are many forms of equity that are applied depending on the type of business of the business. Using the right form of equity will help businesses optimize benefits and enhance competitiveness in the market. FormsEquity consists of:
- State capital: All operating capital is invested by the state.
- Limited Liability Company: Funding is provided by the company's co-founders.
- Joint Stock Company: Capital is contributed from shareholders or business owners.
- Partnership company: An enterprise with at least two general partners contributing capital.
- Sole Proprietorship: Provided by the business owner and held liable with the assets of the individual or entity.
- Joint venture: Capital comes from domestic and foreign partners.
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Formula for calculating equity
Understanding how equity is calculated is the first thing a business needs to do when going into business. The formula for calculating equity will help businesses assess their financial position and make appropriate business decisions.Formula to calculate equity of the business are:
Equity = Total assets of the business - total liabilities.
In there:
- Total assets of a business include short-term assets and long-term assets. Short-term assets include bank deposits, cash, convertible assets such as gold, silver,... Long-term assets include financial investments, real estate, fixed assets, receipts and a few others.
- Liabilities include payments to vendors, taxes, payments to the State, wages, internal payments, financial loans, etc.
Formula to calculate equityFor example, if a business has assets such as a stock investment of VND6 billion, plant equipment costs of VND4 billion, inventory valued at VND2 billion, and manufacturing company revenues of VND3 billion. copper. Meanwhile, the enterprise has a loan of 3 billion VND to buy tools for the factory, 2 billion VND for packaging suppliers and 400 million VND for employees. So, the company's equity will be calculated by the formula: (6 + 4 + 2 + 3) - (2 + 0.2 + 2) = VND 9.6 billion.
Distinguish between equity and charter capital
According to Clause 34, Article 4 of the Enterprise Law 2020:
“Charter capital is the total value of assets contributed or pledged to contribute by members and owners when establishing a partnership or limited liability company. Is the total par value of shares sold or purchased at the time of establishment of the joint stock company.”
Equity and charter capital are two important economic concepts in the financial management of an enterprise. Although both are related to capital, however, the two concepts have different characteristics. Distinction table equity and charter capital The following will help readers better understand this issue:
| | Equity | Authorized capital |
| Nature | The capital that owners contribute to the business, including capital from business results | Is the total amount that shareholders contribute to the business upon its establishment, is determined in the business license and cannot be changed easily. |
| Ownership object | The State, organizations and individuals contribute capital to establish an enterprise or individuals or organizations hold shares | Established by an organization, individual or committed to contribute capital |
| Formation mechanism | Formed from capital sources contributed by the State, individuals and enterprises or supplemented from annual profits. | Formed on the basis of capital contributed by individuals, organizations or committed to contribute capital for a certain period of time and recorded in the charter of the enterprise. |
| Characteristic | Not a debt because of capital contribution from investors, shareholders and business results. | Considered a debt of the company if the business goes bankrupt |
| Meaning | Shows the increase or decrease of capital sources of enterprises and investors | Reflecting the capital structure in the business is the basis for dividing risks or profits with investors |
Hope the above information of Viindoo helped you have an overview of "What is equity?" Understanding equity helps managers easily make the right decisions, determine the financial capacity of the business, thereby making appropriate business strategies.
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