Equity Claim

Definition of Equity Claim

Also known as a residual claim, an equity claim is defined as the claim a specific party has on the earnings of a company after all debts have been satisfied. Generally speaking, an equity claim relates directly to the stake that holders of common shares of stock have in the company. It is most commonly used to refer to the equity claims made against a company’s financial assets during liquidation, receivership, or bankruptcy.

Ownership Equity

Due to the laws governing debt and equity, shareholders are the last to be paid in the event of a company’s failure. Creditors are ranked by priority and are paid first out of company proceeds and assets; only after all other creditors have been paid do the claims in equity of shareholders come into play. Because this ownership equity is paid from the remaining funds, it is typically paid at a rate lower than its original value. In some cases shareholders may receive no money at all, losing both any potential profits and their initial investment. For this reason, ownership equity is often referred to as risk capital, as the funds invested are considered to be at risk.

Equity Claims in Accounting

Due to the risks inherent in stock market investment, it is essential for shareholders to maintain a clear picture of the financial condition of the companies in which they have invested. Luckily, the equity claim figure appears as ownership equity and is included in the balance sheet figures made available as part of corporate annual reports. By carefully examining these figures and comparing them with the total amount of shares outstanding, shareholders can determine the level of security of their initial investment and the likelihood of profitability in the future.

Equity Investments

Because purchase of shares in a company’s stock constitutes an equity claim against the company’s profits, these shares are known as equity investments. Financial investment in start-up companies is usually referred to as venture capital investment, and is considered to be high-risk in comparison to other equity claim investments due to the high initial failure rate of such companies. In order to reduce the overall risk in equity investments, many analysts recommend diversifying one’s portfolio. This method spreads the risk over a number of different companies and levels of risk, theoretically maximizing returns while protecting the bulk of investment funds in safer investment options. Mutual funds are another method of reducing risk; by pooling funds with other investors and spreading the costs and benefits across a wider group of investments, individual investors can limit their losses and ensure long-term financial security.

Book Value of Ownership Equity

A number of factors can affect the current value of a shareholder’s equity claim; these include depreciation of assets, increases or decreases in company profitability, share repurchases and new issuances of stock, and certain dividend payments, especially those to holders of preferred stock. Anything that affects the company’s overall profitability, value of assets, or indebtedness can have an effect on the value of the shareholder’s equity claim.
Tim Ord
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