Equity Share Meaning
An equity share, or an ordinary share, is a fractional ownership that commences the maximum entrepreneurial obligation associated with a trading firm. These categories of shareholders have the power to vote in any corporation.
Features of Equity Shares Capital
- The corporation retains its equity share capital. It is only returned after the firm is closed.
- Equity Shareholders have voting rights and help to choose the company’s management.
- The dividend rate on equity capital is determined by the availability of surplus capital. However, there is no set dividend rate on equity capital.
Types of Equity Share
- Authorized Share Capital- This is the maximum amount that an organization can issue. This sum can be altered at any moment based on the company’s advice and with a few formalities.
- Issued Share Capital- This is the approved capital that a company provides to its stockholders.
- Subscribed Share Capital- A part of the issued capital accepted and agreed upon by an investor.
- Paid-Up Capital- This is a portion of the subscribed capital provided by the investors. Paid-up capital is the money that a firm invests in its operations.
- Right Share- These are the shares that a company issues to its current investors. This form of share is issued by the corporation to protect the property rights of existing investors.
- Bonus Share – A bonus share is when a company divides its shares among its owners in the form of a dividend.
- Sweat Equity Share- This sort of share is only given to exceptional employees or executives of a company for their great efforts in giving intellectual property rights to the company.
Merits of Equity Shares Capital
- The term ES (equity shares) does not imply a sense of responsibility or accountability to pay a predetermined dividend rate.
- ES can be distributed even without imposing any further expenses on a company’s assets.
- It is a continuous source of finance, and the firm must repay it; in unusual instances, it may be liquidated.
- Equity shareholders are the true owners of the company and have voting rights.
Demerits of Equity Shares Capital
- When only equity shares are issued, the firm cannot claim credit or gain an advantage if equity trading.
- Overcapitalization poses a risk or obligation since equity capital cannot be regained.
- By directing and systematizing themselves, management may overcome obstacles from equity owners.
- When a company produces greater profits, higher dividends must be paid, which raises the value of its shares on the market and opens the door to speculation.
Difference between Equity Shares and Preference Shares
A company’s shares are divided into two types: equity shares and preference shares. An ordinary share is an equity share. Preference shares are the first to benefit from dividend distribution. Equity investors are given the right to vote on significant corporate decisions.
The dividend is paid at a predetermined rate to the business preference share. When there is a problem with the firm, the preference share has the right to return the capital first, followed by the equity share.
| Parameters | Preference Share | Equity Share |
|---|---|---|
| Dividend Rate | Has a fixed rate | Fluctuates |
| Vote Rights | No voting rights | Have voting rights |
| Participation in Management | Has no right to participate in management decision | Has the right to participate in management decision |
| Preferences | Get the first preference, before the equity share | Gets second preference, after preference share |
What are the main objectives of financial management?
Financial management’s principal goal is to maximize shareholder wealth by increasing the current market value of equity shares.
(a) Maximize shareholder’s wealth
- This is the main goal of financial management, sometimes known as “the wealth maximization concept.”
- This entails maximizing the present market value of the company’s equity shares, which is only feasible if finances are used optimally to meet organizational goals.
- The wealth of a shareholder can be estimated as follows:
The number of equity shares owned by a shareholder multiplied by the current market value of each share.
(b) Procurement of sufficient funds at the lowest possible costs
- Finances must be obtained at the lowest feasible cost.
- The corporation should make every effort to reduce the cost of obtaining financing.
- The cost of capital is a critical factor in determining the long-term effectiveness of a financial plan.
(c) Optimum utilization of acquired funds
- The main problem that an organization has is ensuring that the profits outweigh the expenditures.
- This goal guarantees that available resources are used effectively and efficiently.
(d) Ensure safety of investment
- A solid financial decision is based on the investment’s safety.
- Companies must establish and manage financial reserves.
- To maximize the return on investment, the money should be invested wisely.
(e) To achieve a sound capital structure
- A correct balance of equity and debt should be maintained to provide a sound and equitable capital structure.
Explain the Concept of Capital Structure
Meaning of capital structure
- The capital structure is made up of a combination of owner money (Equity) and borrowed funds (Debt).
- More debt raises risks while decreasing profits owing to lower costs. As a result, additional debt should be brought into the capital structure while keeping risk in mind.
- As a result, a corporation should optimize risk and return while selecting a capital structure that optimizes shareholder value.
- Total Capital = Debt + Equity Capital Structure
What Are the Factors Affecting the Capital Structure?
(a) Cash flow position
- Before issuing debt, a corporation must assess its cash flow condition.
- Cash must be adequate to cover operational expenditures or to pay fixed liabilities.
- In addition, the corporation should have a buffer in place to deal with future uncertainty.
(b) Return on investment (ROI)
High ROI
- It signifies that the return on investment is more than the interest rate.
- That suggests the company’s investment will yield a favorable return.
- As a result, it is advantageous for a corporation to raise capital through borrowed funds.
- This is also known as stock trading.
- This finally optimizes the company’s Earnings per Share (EPS).
Low ROI
- It signifies that the return on investment is less than the interest rate.
- That means the corporation cannot produce a satisfactory return on its investment.
- As a result, if a corporation generates capital using borrowed funds, it will not benefit.
- This eventually affects the company’s earnings per share (EPS).
(c) Cost of Debt
- The cost of debt is the rate of interest due on debentures, loans, or borrowed cash.
- If the corporation can borrow at a cheaper interest rate, its borrowing power grows and it may take on more debt.
(d) Cost of Equity
- Debt increases financial risk for equity owners, which raises the needed rate of return for equity shareholders.
- If debt is employed over a particular threshold, the cost of equity rises substantially and EPS falls.
(e) Floatation cost
- The floating cost is the expense of fundraising.
- The public issuance of the debenture will be more expensive than borrowing from any financial institution.
(f) Risk consideration
- The company faces two categories of business risk:
(i) Financial risk: Risk of repayment of debt.
(ii) Operating risk: Risk of recovering operating expenses.
- When the firm’s business risk is smaller, so is its capacity to employ debt.
(g) Stock market condition
Bullish Phase
- Raising equity during a bull market is simple since equity shares may be sold at a greater price.
Bearish Phase
- Debt is a superior choice for raising cash during a down market in the stock market.
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