In the world of finance, equity refers to any money companies generate through their shareholders or businesses through their owners. Equity is a type of finance that companies use when starting up and down the line when they need funds.
However, there’s also another word that people often use called capital. While these are similar terms that describe funds, they are also different due to several reasons.
The top 6 differences between equity and capital are as below.
Equity is a term used in finance to describe shareholders’ equity of a company. The definition of equity in the world of finance is the amount of money that the company’s shareholders will get if a company liquidates after it pays off all its debts using its assets. In other words, equity is the residual amount after deducting the liabilities of a company from its assets.
Capital is a word associated with different aspects of a business. Most commonly, capital refers to the injection of funds into a business by its owner. For companies, it comes in the form of paid-in capital, also known as share capital.
When the owner of a business invests in it, they expect to make profits. While the investment is its capital, the earnings aren’t. In contrast, profits make a part of the equity of a business.
If the owner or shareholder chooses to reinvest the money in the business or company, then it qualifies as capital. Therefore, any returns that shareholders get that the company uses are not capital.
On the other hand, if the owner does not reinvest in the money or withdraw it, then the earnings stay within the business. In that case, the profits become retained earnings and are a part of equity rather than capital.
When a company makes losses, it results in a decrease in its equity. Therefore, the rights of its shareholder also decrease. However, losses do not affect the capital of a company or business.
For companies, losses do not impact share capital or share premium. Therefore, it only affects the shareholders’ equity of a company.
On the other hand, for normal businesses, losses don’t affect the owners’ capital or investment in them. The capital of the business will remain the same, even if it goes into losses. Similarly, companies or businesses cannot replace their losses with capital and vice versa.
Equity also includes other reserves of a company. For example, companies may consist of ‘other reserves’ on their Balance Sheet. These reserves also cover several items created from shareholders’ contributions or profits.
However, these reserves are not a part of the capital of a business, which represents the owners’ or shareholders’ investments in it.
In contrast, reserves make up a part of the equity of a company. Almost all large companies have some reserves in their shareholders’ equity portion of their Balance Sheets.
In some cases, these reserves may also include non-monetary amounts. Overall, reserves aren’t a part of the capital of a company but its equity.
5) Revaluation surplus
Another item that is often common in the Balance Sheet of companies is revaluation surplus. Usually, companies that use the fair value method of valuing their assets also have a revaluation surplus due to it.
A revaluation surplus is a non-monetary amount. Similarly, it is a part of a company’s equity because it does not relate to the shareholders.
Therefore, the revaluation surplus is another differentiating factor between capital and equity. While the equity of a company may contain a revaluation surplus, its capital may not.
As mentioned, the main reason for it is that it does not generate from the shareholders of a company but due to its accounting policies and assets used.
6) How they are present in the balance sheet
There are three main elements of financial statements in the balance sheet. They are assets, liabilities, and equity.
In the balance sheet, capital is the subcategories of equity element where equity includes many other items besides capital and share premiums, such as retained earnings or accumulated loss, as well as reservice.
7) Other usages
Equity, as mentioned above, only refers to the shareholders’ rights in a company or owners’ rights in a business. Similarly, capital only represents the investment made in the company or business directly.
However, the word capital also has another usage. It is a word that also describes the overall finance structure of a company.
Therefore, capital is also a term used to describe both the equity and debt of a company. For example, in financial management, capital structure or cost of capital don’t describe investments of owners but the overall finance structure of the company.
|Definition||It is the residual amount after deducting the liabilities of a business from its assets.||It is the investment made by the owners of a business.|
|Profits||Equity includes the profits or retained earnings of a business.||Capital can only increase if owners reinvest profits in the business.|
|Losses||Losses are a part of equity and reduce it.||Losses do not impact the capital of a business.|
|Reserves||Equity consists of reserves along with other items.||Capital does not include any type of reserve.|
|Revaluation surplus||Revaluation surplus is a part of equity.||Capital does not consist of a revaluation surplus.|
|Other usages||Equity is a term used to describe the claim of business owners in their business only.||Capital also means the sum of the total debt and equity of a business.|