Equity represents a company's financial resources. It considers both the resources brought in when the company was created and those generated during the course of its activity.
Equity, also known as "shareholders' equity," represents the company's cash flow. It’s an essential component of the balance sheet.
Equity is made up of a number of financial resources:
- share capital, which is the amount invested when the company was created;
- net income for the financial year;
- additional paid-in capital (merger premium, share premium, etc.);
- accumulated legal reserves (previous profits not distributed); and
- retained earnings (past profits not set aside as reserves and not distributed).
The sum of all these resources is used to calculate a company's equity.
It is also possible to calculate a company's equity using the following formula: equity = company assets - debts.
The amount of shareholders' equity enables us to assess a company's financial health. It’s a true indicator of value.
The higher the amount, the more valuable the company. Conversely, when equity is low, or even negative, the more the company's value is affected.
Various types of events can affect the amount of shareholders' equity. These include the following:
- an increase or decrease in the company's activity;
- transactions relating to share capital, including a capital increase or reduction;
- the distribution of dividends to shareholders, etc.
In the event of a loss of equity, the company may decide at a shareholders' meeting to dissolve the company early or to continue trading in order to rebuild equity. To return to financial health, the company can increase its share capital or reduce or even stop dividend payments to beneficiaries.
Regular monitoring of shareholders' equity is essential to assess the company's health. For this, it’s advisable to enlist the help of a chartered accountant.
What's more, it's best not to wait until the end-of-fiscal-year balance sheet to take stock of shareholders' equity, at the risk of it being too late to remedy any decline.
