In accounting and finance, equity is the residual value or interest of the most junior class of investors in assets, after all liabilities are paid; if liability exceeds assets, negative equity exists.
In an accounting context, shareholders’ equity (or stockholders’ equity, shareholders’ funds, shareholders’ capital or similar terms) represents the remaining interest in the assets of a company, spread among individual shareholders of common or preferred stock; a negative shareholders’ equity is often referred to as a positive shareholders’ deficit.
At the very start of a business, owners put some funding into the business to finance operations. This creates a liability on the business in the shape of capital as the business is a separate entity from its owners.
Businesses can be considered, for accounting purposes, sums of liabilities and assets; this is the accounting equation. After liabilities have been accounted for, the positive remainder is deemed the owners’ interest in the business.
This definition is helpful in understanding the liquidation process in case of bankruptcy. At first, all the secured creditors are paid against proceeds from assets. Afterwards, a series of creditors, ranked in priority sequence, have the next claim/right on the residual proceeds.
Ownership equity is the last or residual claim against assets, paid only after all other creditors are paid. In such cases where even creditors could not get enough money to pay their bills, nothing is left over to reimburse owners’ equity. Thus owners’ equity is reduced to zero. Ownership equity is also known as risk capital or liable capital.