- Assets represent all the economic resources owned or controlled by the company. These assets can include cash, property, plant, equipment, inventory, investments, and other items of value.
- Liabilities are the financial obligations or debts that the company owes to creditors, suppliers, lenders, and other parties. Liabilities include accounts payable, loans, bonds, and other forms of debt.
When you subtract total liabilities from total assets, you get equity, which represents the residual interest or net worth of the company. In essence, equity represents what would be left for the shareholders if all of the company’s assets were sold to pay off its debts. Equity is typically categorized into two main components on a company’s balance sheet:
- Common Equity: This is the portion of equity that belongs to common shareholders, who are the owners of the company’s common stock. Common equity can include the initial investment made by shareholders (common stock), retained earnings (accumulated profits the company has earned and not distributed as dividends), and other comprehensive income (items that impact equity but are not part of the income statement).
- Preferred Equity (if applicable): Some companies issue preferred stock in addition to common stock. Preferred shareholders have a higher claim on the company’s assets and earnings compared to common shareholders. Preferred equity represents the ownership interest of preferred shareholders.
Equity is an important indicator of a company’s financial health and is used to assess the company’s net worth and its ability to meet its obligations. It is also a key factor in determining the financial leverage (debt-to-equity ratio) of the company, which can impact its risk profile and cost of capital. Shareholders often monitor equity as it reflects their stake in the company’s value and profitability.