Equity Vs. Capital: 6 Differences You Should Know
Definition of Equity
Equity can be defined as the residual ownership in a company or asset after subtracting all associated debts. It is the value returned to shareholders if all assets were liquidated and all debts were paid off.
Equity is shown on a company’s balance sheet and represents the shareholders’ stake in the company.
The calculation of equity is the difference between total assets and total liabilities.
Equity is used in financial ratios such as Return on Equity (ROE). This type of ratio measures the efficiency and profitability of a company and its ability to generate returns on the invested capital.
Definition of Capital
Capital refers to the money a business has for its operations and growth, which can take the form of debt, equity, working capital, or trading capital.
Working capital is the short-term capital used to finance day-to-day operations, while debt capital creates a liability on the balance sheet.
Equity is the capital received from investors in exchange for a share of ownership in the company.
Trading capital is used by brokerages and financial institutions to buy and sell securities.
The capital structure of a company determines the mix of capital sources used for funding. It is important for companies to have the right mix of capital to ensure financial stability and the ability to grow and expand.
Sources of Equity
Businesses can tap into various sources of equity finance, such as business angels, venture capital, crowdfunding, the Enterprise Investment Scheme (EIS), and the Alternative Platform Finance Scheme, to help fuel their growth and expansion.
Business angels are wealthy individuals who invest in high-growth businesses in exchange for a share in the business, while venture capital is a source of equity finance where investors provide funding to high-potential startups in exchange for equity or ownership.
Crowdfunding is a method of raising finance by gathering small amounts of money from a large number of people through an online platform.
The Enterprise Investment Scheme (EIS) is a government initiative that offers tax incentives to individuals who invest in eligible startups, while the Alternative Platform Finance Scheme is another government-backed program that provides financing options for businesses through alternative platforms.
The stock market is also a source of equity finance where companies can offer shares of their ownership to the public in exchange for funding.
Sources of Capital
Using various sources of capital, businesses can finance their operations, growth, and expansion.
- Bonds, bank capital, credit union capital, and foundation grants and funds are all sources of capital that businesses can use.
- Community Reinvestment Act funds and federal funds are also potential sources of capital.
- Furthermore, state governments may provide funding for businesses in the form of grants or loans.
Each of these sources of capital can provide the necessary funds for businesses to grow and expand.
However, each source of capital has its own set of requirements and restrictions that businesses must adhere to.
For instance, government-funded sources of capital often come with restrictions on how the money can be used, while other sources may have requirements in terms of repayment terms and interest rates.
Additionally, businesses must be mindful of the terms and conditions of the capital source, as well as any associated fees and taxes.
Uses of Equity
Equity, when utilized correctly, can be a powerful tool for businesses to finance operations, growth, and expansion. Equity is a form of financing that is not debt and is not linked to repayment, as it is issued to owners or investors. When used as a financing method, equity can provide funds for a business to use however it sees fit, whether that be to expand, develop, or start a new project.
| Benefits | Drawbacks |
|---|---|
| High level of flexibility | Dilution of ownership |
| No requirement for repayment | No guarantee of returns |
| Potential for high returns | Risk of total loss |
| Greater control over company decisions | High cost of raising equity capital |
Uses of Capital
In contrast to equity, capital is generally used to finance operations of a company.
Capital can be used to purchase inventory, hire new employees, and fund research and development projects, all of which can help to maximize profits.
It can also be used to finance expansions and acquisitions of other companies. This can help to create a larger market share, and increased profits.
Capital can also be used to pay down debt, which can help to improve the balance sheet of a company.
Equity vs. Capital for Businesses
Comparing the two financial instruments of business, equity and capital, can be a beneficial exercise for understanding the differences between them. Equity represents the ownership interest in a business entity, while capital is the total amount of money invested in the company. Capital can be sourced from personal savings, loans, or investments, while equity can be raised through IPOs, crowdfunding, or private placements.
| Equity | Capital |
|---|---|
| Represents the ownership interest in a business entity | Total amount of money invested in a company |
| Raised through IPOs, crowdfunding, or private placements | Sourced from personal savings, loans, or investments |
| Value of assets minus liabilities | |
| Can increase or decrease depending on the company’s performance |
Conclusion
In conclusion, equity and capital are two distinct concepts that are important to consider when managing the finances of a business.
Equity is the ownership of a business, while capital is the money used to finance a business.
Equity is typically sourced from investors, whereas capital is sourced from lenders or investors.
Equity is used to purchase assets and finance operations, while capital is used to finance operations, purchase assets, and pay debts.