Equity, also known as shareholder's equity or net worth, is the difference between a company's assets and liabilities. It indicates the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid.
Working of Equity
The value of shareholder equity is derived by subtracting a company’s liabilities from its assets. It is an indicator of a company’s financial health.
Companies can increase their equity by issuing debt or equity. Investors typically prefer equity investments due to their potential for capital gains and dividends.
Positive equity signifies the company's ability to cover its liabilities, whereas negative equity implies liabilities exceeding assets. Consistent negative equity is an indication of balance sheet insolvency.
While negative equity is seen as a risky investment, shareholder equity alone does not provide a complete picture of a company’s financial health. Other factors like the debt-to-equity ratio, return on equity, and cash flow should also be considered.