The equity of a company

Defined for everyone's understanding, the own capital of a company represents the amounts of money due to the shareholders, in the situation in which all the assets are capitalized and all the debts of the company are paid. In specialized parlance, equity is also called a net asset.  Depending on the values of assets and liabilities, equity can be positive (total assets greater than liabilities) or negative (if the liabilities are greater than the amount of assets).

Why does the level of equity matter?

Equity is the main indicator of the financial health of the company. When the cumulative value of the assets is less than that of the liabilities it means that the firm is facing financial difficulties that, if no action is taken, will worsen in the near future.

A low level of net assets indicates that the entity does not have the financial power to develop with its own resources, has a high degree of indebtedness and is in a situation where it cannot pay its creditors, suppliers, taxes or employees from its own sources. Thus, the continuity of the company's economic activity is questioned.

Also, companies with positive equity are "bankable", in the sense that banks are attracted by such potential customers, having very high reluctance to provide financing to over-indebted companies. Accessing financing from European funds can be achieved only if the applicant company is profitable and has positive capital.

A very important aspect, which must be emphasized, is that companies with positive equity are the ones that can benefit from tax incentives according to O.U.G. 153/2020.

How do I find out what equity my company has?

The statement of equity is presented in the annual financial statements of the company, more specifically in the balance sheet. Here are listed the elements that make up the equity of a company: share capital, capital premiums, revaluation reserves, legal reserves, profit and loss carried forward, and the financial result of the year. Row 46 of the balance sheet represents the total of all these items. If the amount presented on this line is positive, it means that the value of the firm's assets is higher than the accumulated debts, so the equity capital is positive. If the situation is reversed, the debts are higher, then the company's equity is negative.

How can the equity situation improve?

There are several possibilities for this:

  a) reduction of the amount of dividends distributed to shareholders. Thus, a large part of the retained earnings from previous financial years remains available to the company. It is a short-term solution, but it is not a viable option in the medium and long term, due to the fact that the purpose for which the shareholders have invested in the company is precisely to obtain dividends;

  b) the increase of the share capital, which can be made in money or in kind. This operation involves new capital contributions from shareholders or the co-optation of other persons in the company, an operation not always within the reach of anyone;

  c) the constitution of reserves, during the periods in which the company registers profit, but this involves limiting the granting of dividends to shareholders;

  d) revaluation of assets for entry in the financial statements, if the present fair value of the assets will increase as a result of the revaluation, and revaluation reserves will be constituted - a component part of the equity.

In conclusion, it should be stressed that a poorly capitalized company has insufficient own resources to ensure the continuity of economic activity. In addition, it has a very limited capability in attracting some financing from outside the company. Revaluation of assets could be an effective way to improve the equity situation.

With over 17 years of experience in valuation, FairValue has a strong team of experts in accounting, finance, fixed assets and intellectual property. The over 60 evaluators across the country, who make up the #fairvalueteam, are ready to respond promptly to any valuation request in the field of financial reporting, regardless of its complexity and the location of the assets in Romania.

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