A lot of people keep confusing the owner’s equity and net worth. This has caused these terms to be used interchangeably between each other. Although, it may seem like the definition is kind of similar in reality it is not so. There is one huge difference between the two.
Let’s take a random company X for example and use it as a reference for comparisons. The equity would be defined as an individual shareholder’s investment in the business X itself, however, the net worth would be defined as a whole value of the company including everything that it owns like furniture, offices, rugs, computers, etc.
So basically the idea is that a lot of people mess up the terminology and believe that both of these terms represent something that is left after paying all of the liabilities. The net worth is increased by decreasing the liabilities. This is different from the equity when trading forex, which is simply the total value of the FX trader’s account. Traders usually have their positions open in the market making the total equity the sum of the margin that is put up for trade in addition to the unused balance.
When it comes to shareholder equity we have to take a look at company X and its balance sheet. The sheet itself is divided into three main categories. These are assets, shareholder equities, and liabilities. The shareholder’s equity is represented as the difference between the whole amount of assets and the total liabilities of the company X. For example, if the X has $1,000,000 in total assets and $700,000 in liabilities the equity comes down to $300,000.
The shareholder’s equity consists of other things. These are things like preference share capital, share capital, retained earnings, and etc.
Share Capital, or sometimes referred to as the capital stock is a portion of corporations’ equity, which was acquired by the shareholder via the issue of shares in the company. It may also be denoted as the number of shares that make up the corporation’s share structure. Basically it is the amount of money collected from issuing both private and public sources of the company and is showcased under the owner’s equity in the balance sheet of the company. The share capital has nothing to do with the market value of the company itself. Meaning that the balance sheet of the company is going to be including what the company earned despite the market value. Apart from this, the share capital only takes into account the price issued by the shares. Basically, if X has 1000 shares and each cost $5 this means that the share capital would be $5000. Even if the time passes and the market price of each share becomes more expensive the share capital will remain the same until the company issues new shares.
Preferred share is a share that has a priority when receiving dividends. The dividend may be floating or fixed in comparison to the common shares. Preferred shareholders also may not have the right to vote although they have priority when it comes to giving out the claims at the time of liquidation.
The retained earnings are the net amount of income that is left to the company after it pays out dividends to the shareholders. This in the end dictates whether the business generated positive or negative income. In simpler terms, profits or losses. The idea is that when the company generates some kind of surplus income it pays dividends to the shareholders for putting faith and finances into the company. This differs from company to company, however, there are always some that pay more than others. Some traders who want short-term gains prefer dividends due to the fact that they offer instant income. The dividends are also tax-free income meaning that a lot of people do not pay anything to the government for this specific source of income making it more appealing. Sometimes the federal government may interfere and lock down the share buybacks and bank payouts to protect the company cash outflow. This has been done in the United States, for example, to protect the companies from money outflow. Some of the shareholders trust the management enough to leave the earnings into the company waiting for higher returns, although these may even contain taxes.