Equity or Net Worth is the last to mature source of funds. It is the owners' share in the financing of all the assets. There are two types of equity; purchased equity and earned equity.
Purchased Equity
Consists of:
- Preferred Stock (P/S)
- Common or Capital Stock (C/S)
- Paid in Capital
It represents the cash the owners have invested in the company in the form of stock. Stock comes in several forms:
- Preferred Stock (P/S) is stock that has some preference to common stock. Generally, preferred stockholders receive a dividend before common stockholders, and if the company is ever liquidated, they will receive a share in liquidation proceeds prior to common stockholders.
- Common Stock (C/S) is the general ownership. It is last to be paid source of funds.
- Paid in Capital is created if either the preferred or common stock is quoted at an arbitrary par value. Should par value exist and should the stock be purchased in excess of par value, the par value of the stock is credited to common or preferred stock, while the excess is credited to the paid in capital.
Par value is an anomaly that was born in early stock market days. In early American law, the stockholders could be held liable for obligations in excess of their investment into the stock. To prevent unlimited liability, laws were passed that limited liability to the par value investment. Par values were then chosen at arbitrarily small figures to protect stockholders from additional liability.
Earned Equity (R/E)
Consists of retained earnings (also called earned surplus). It represents profits earned by the
company and retained in the business. It is a measure of past profitability and represents
earnings the owners could have withdrawn to use personally (by declaring and paying
dividends), but chose to reinvest in the business.
Treasury Stock
Is a contra-account showing a decrease in net worth. Treasury stock
is created when a company purchases its own stock from its stockholders. The owner surrenders
stock certificates to the company, which deposits them in the treasury (hence the name).
Learn more about the other sections of the Balance Sheet:
Assets
Liabilities
