Equity Capital: In Conclusion
July 29th, 2010
Copyright © 2010 Integrated Profitability TM
To summarize this series:
● Equity = assets – liabilities
● Investors provide initial equity
● Equity grows by the amount of positive net-profit that is invested back in the business
● Equity allows a business to grow and invest in itself
● Equity is a cushion to handle inevitable financial stresses in business
● A prudent amount of equity to have is the amount needed to cover a full year of your business’s potential, combined net-losses
The “Small Business Finance & Profitability” (SBF&P) series on Equity-capital started with this question from a reader:
“Good! Finally all of this is coming together for me. How about more on capital? What is it? where does it come from, is it actual & stored somewhere physically and separately or virtual like the net or sum of two or more numbers?”
After an unintended tangent (Capital: Mea Culpa), here’s the answer to the last question:
● Equity-capital is the result of “Assets – Liabilities”
● Both assets and liabilities have an actual, a physical nature
- Assets: cash can be held in your hand; equipment is surely physical
- Liabilities: loan papers are signed; invoices create Accounts Payable
Equity-capital, however, is not tangible in these ways. It is, in fact, “…virtual like the net or sum of two or more numbers…”
Bill
William A. Stong
Email: william.a.stong@gmail.com
SBF&P # 73
Telephone: 925-202-6244
Copyright © 2010 Integrated Profitability TM
Equity Capital: Where’s it at?
July 22nd, 2010
Copyright © 2010 Integrated Profitability TM
At the end of the day, if the negative pressures on your company’s profit require you to access the equity-capital you built up over the years, where’s it at? How do you tap that safety net?
Liquidate assets
Basically, you draw down your assets to pay for the negative profitability that is pounding your company. The first asset, of course, is “Cash”:
● Use cash to pay expenses
● In order to keep the Balance Sheet in balance, equity-capital will decrease
(NB: let’s ignore the complicating reality that many of these transactions will flow through “Accounts Payable” liabilities first. The point here is that eventually, when revenue is less than expense, equity-capital will ultimately be used to fund the negative net-profits).
Assets have different liquidity characteristics. With the most drastic scenario, equity-capital is accessed by liquidating all assets and using the proceeds from those asset sales to pay off all liabilities (or as many as can be paid off).
Whatever is left is equity-capital: positive or negative.
Bill
William A. Stong
Email: william.a.stong@gmail.com
SBF&P # 72
Telephone: 925-202-6244
Copyright © 2010 Integrated Profitability TM
Equity Capital: Intriguing Weirdnesses
July 15th, 2010
Copyright © 2010 Integrated Profitability TM
Near the beginning of this series on equity- capital, Equity Structures: Market Examples & Other Names for Equity went over the basic components of a company’s equity structure. In the beginning of a company’s life, the equity part of the balance sheet is straightforward:
● Preferred Stock (if issued)
● Common Stock
● Capital in Excess of par value
As long as the company has straightforward business experiences, equity capital remains a clear, straightforward set of accounts.
Assuming the company is making a net-profit and at least some of that is poured back into the business, then a new equity account is added and begins to grow with each year there is a final, positive net-profit:
● Retained earnings
Unfortunately, not everything goes according to plan in the business world. As the earlier article showed, depending on the financial situation of a company, other less clear equity accounts are added. Conceptually, making a profit is simple: sell for more than it costs. This doesn’t always happen in the real world and when it doesn’t, accountants still have to account for it. Here are some examples:
● Accumulated other comprehensive income/(loss)
● Employee benefit trust
● Treasury stock (aka Common Stock in treasury)
● Guaranteed ESOP Obligations
● Accumulated undistributed (overdistributed) net investment income (loss)
● Accumulated undistributed (overdistributed) net realized gain (loss)
● Net unrealized appreciation (depreciation) on:
- Investments
- Foreign currency translations
- Foreign capital gains tax
- Written options
What interesting, possibly mysterious, equity accounts have you come across?
Bill
William A. Stong
Email: william.a.stong@gmail.com
SBF&P # 71
Telephone: 925-202-6244
Copyright © 2010 Integrated Profitability TM
Accessing Capital
July 8th, 2010
Copyright © 2010 Integrated Profitability TM
For any business, there are two ways to obtain capital:
● Borrow the money (e.g., loans)
● Sell ownership stakes (i.e., share in equity)
Loans are provided by entities that have capital they are looking to invest and who, when they look at your company, see, and believe in, a clear source of repayment. Early qualifiers for commercial lending are credit ratings and past history of a business’s ability to consistently generate profit.
Equity investments in a business are driven by investors who see, and believe in, the ultimate market success of a product or service and believe that the owners/management team have the skills, experience, and dedication to achieve that success.
In both cases, small businesses have distinct disadvantages:
● May lack a long history of profitable success
● Business model may only deliver small profits
● Creditworthiness may not yet be established
● Much larger competitors may exist in the same market
Bottomline is that these sources of capital may be scarce. If, therefore, your small business is funded by money from your savings or from friends and family, decide which type of capital it is. Ultimately it makes a difference to both sides:
With a positive outcome (e.g., successful profitability growth)
1. Loan
- means your business will pay the money back plus an agreed upon interest amount
- people who advanced the funds eventually receive principal and earnings
2. Equity
- means your business will give the investor a pro-rata share of any money taken out of the business (e.g., dividends, sale of the business)
With a negative outcome (e.g., goes out of business)
1. Loan
- the severity of the bankruptcy will determine how much, if any, of the original loan will be repaid. Usually, creditors receive some fraction of their money back.
2. Equity
- again, the severity of the bankruptcy will determine how much, if any, of the original investment will be received. Equity holders, however, receive no money until all creditors are paid. Thus, if creditors usually only receive a fraction of their loans back, equity investors will receive nothing.
Bill
William A. Stong
Email: william.a.stong@gmail.com
SBF&P # 70
Telephone: 925-202-6244
Copyright © 2010 Integrated Profitability TM
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