Liability Management

By

WILL KENTON

Updated July 12, 2022

Reviewed by

SAMANTHA SILBERSTEIN

What Is Liability Management?

Liability management is the practice by banks of maintaining a balance
between the maturities of their assets and their liabilities in order to maintain
liquidity and to facilitate lending while also maintaining healthy balance
sheets. In this context, liabilities include depositors’ money as well as funds
borrowed from other financial institutions.

A bank practicing liability management looks after these funds and also
hedges against changes in interest rates. A bank can face a mismatch
between assets and liabilities because of illiquidity or changes in interest
rates; and liability management reduces the likelihood of a mismatch.

KEY TAKEAWAYS

 Liability management is the process of managing the use of assets and

cash flows to reduce the firm’s risk of loss from not paying a liability on
time.
 Well-managed assets and liabilities involve a process of matching
offsetting items that can increase business profits.
  The asset-liability management process is typically applied to bank loan
portfolios that may offer fixed-term products such as CDs and loans but
also demand deposits and lines of credit.
 Defined-benefit pension plans may also use liability management to
ensure it does not experience a cash shortfall for paying its future and
current obligations.

Understanding Liability Management

A bank must pay interest on deposits and also charge a rate of interest on
loans. To manage these two variables, bankers track the net interest
margin or the difference between the interest paid on deposits and interest
earned on loans.

Banks began to actively manage assets vs. liabilities in the 1960s by

issuing negotiable CDs. These could be sold prior to maturity in
the secondary market in order to raise additional capital in the money market.
Also known as asset/liability management , this strategy plays an important in
the health of a bank's bottom line. During the run-up to the 2007–08 financial
crisis, some banks mismanaged liabilities by relying on short-maturity debt
borrowed from other banks to fund long-maturity mortgages, a practice that
contributed to the failure of U.K. mortgage lender Northern Rock, according to
a government report on the crisis.

An asset-liability committee (ALCO), also known as a bank's surplus

management team, is a supervisory group that coordinates the management
of assets and liabilities with a goal of earning adequate returns. By managing
a company's liabilities effectively, the ALCO provides oversight for better
evaluating on- and off-balance-sheet risk for an institution. Members
incorporate interest rate risk and liquidity consideration into a bank’s
operating model.

The Banking Industry

As a financial intermediary, banks accept deposits for which they are
obligated to pay interest (liabilities) and offer loans for which they receive
interest (assets). In addition to loans, security portfolios also compose bank
assets. Banks must manage interest rate risk, which can lead to a mismatch
of assets and liabilities. Volatile interest rates and the abolition of Regulation
Q, which capped the rate at which banks could pay depositors, contributed to
this problem.
A bank’s net interest margin—the difference between the rate that it pays on
deposits and the rate that it receives on its assets (loans and securities)—is a
function of interest rate sensitivity and the volume and mix of assets and
liabilities. To the extent that a bank borrows in the short term and lends for
the long term, there is often a mismatch that the bank must address through
the structuring of its assets and liabilities or with the use of derivatives (e.g.,
swaps, swaptions, options, and futures) to ensure it satisfies all of its
liabilities.

Liability Management in Pension Plans

A defined benefit (DB) pension plan provides a fixed, pre-established pension
benefit for employees upon retirement, and the employer carries the risk that
assets invested in the pension plan may not be sufficient to pay all benefits.
Companies must forecast the dollar amount of assets available to pay
benefits required by a defined benefit plan.

Assume, for example, that a group of employees must receive a total of $1.5
million in pension payments starting in 10 years. The company must estimate
a rate of return on the dollars invested in the pension plan and determine how
much the firm must contribute each year before the first payments begin in 10
years.

Liability: Definition, Types, Example, and

Assets vs. Liabilities
By

ADAM HAYES

Updated July 05, 2022

Reviewed by

SOMER ANDERSON
Fact checked by

KIRSTEN ROHRS SCHMITT

Investopedia / NoNo Flores

What Is a Liability?
A liability is something a person or company owes, usually a sum of money.
Liabilities are settled over time through the transfer of economic benefits
including money, goods, or services.

Recorded on the right side of the balance sheet, liabilities include

loans, accounts payable, mortgages, deferred revenues, bonds, warranties,
and accrued expenses.

Liabilities can be contrasted with assets. Liabilities refer to things that you
owe or have borrowed; assets are things that you own or are owed.

KEY TAKEAWAYS

 A liability (generally speaking) is something that is owed to somebody

else.
 Liability can also mean a legal or regulatory risk or obligation.
 In accounting, companies book liabilities in opposition to assets.
 Current liabilities are a company's short-term financial obligations that
are due within one year or a normal operating cycle (e.g. accounts
payable).
 Long-term (non-current) liabilities are obligations listed on the balance
sheet not due for more than a year.
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1:47

What's a Liability?

How Liabilities Work

In general, a liability is an obligation between one party and another not yet
completed or paid for. In the world of accounting, a financial liability is also an
obligation but is more defined by previous business transactions, events,
sales, exchange of assets or services, or anything that would provide
economic benefit at a later date. Current liabilities are usually
considered short-term (expected to be concluded in 12 months or less) and
non-current liabilities are long-term (12 months or greater).

Liabilities are categorized as current or non-current depending on their

temporality. They can include a future service owed to others (short- or long-
term borrowing from banks, individuals, or other entities) or a previous
transaction that has created an unsettled obligation. The most common
liabilities are usually the largest like accounts payable and bonds payable.
Most companies will have these two line items on their balance sheet, as they
are part of ongoing current and long-term operations.

Liabilities are a vital aspect of a company because they are used to finance
operations and pay for large expansions. They can also make transactions
between businesses more efficient. For example, in most cases, if a wine
supplier sells a case of wine to a restaurant, it does not demand payment
when it delivers the goods. Rather, it invoices the restaurant for the purchase
to streamline the drop-off and make paying easier for the restaurant.

The outstanding money that the restaurant owes to its wine supplier is
considered a liability. In contrast, the wine supplier considers the money it is
owed to be an asset.

Liability may also refer to the legal liability of a business or individual. For
example, many businesses take out liability insurance in case a customer or
employee sues them for negligence.

Other Definitions of Liability

Generally, liability refers to the state of being responsible for something, and
this term can refer to any money or service owed to another party. Tax
liability, for example, can refer to the property taxes that a homeowner owes
to the municipal government or the income tax he owes to the federal
government. When a retailer collects sales tax from a customer, they have a
sales tax liability on their books until they remit those funds to the
county/city/state.

Liability can also refer to one's potential damages in a civil lawsuit.

Types of Liabilities
Businesses sort their liabilities into two categories: current and long-term.
Current liabilities are debts payable within one year, while long-term
liabilities are debts payable over a longer period. For example, if a business
takes out a mortgage payable over a 15-year period, that is a long-term
liability. However, the mortgage payments that are due during the current
year are considered the current portion of long-term debt and are recorded in
the short-term liabilities section of the balance sheet.

Current (Near-Term) Liabilities

Ideally, analysts want to see that a company can pay current liabilities, which
are due within a year, with cash. Some examples of short-term liabilities
include payroll expenses and accounts payable, which include money owed
to vendors, monthly utilities, and similar expenses. Other examples include:

 Wages Payable: The total amount of accrued income employees have

earned but not yet received. Since most companies pay their
employees every two weeks, this liability changes often.
 Interest Payable: Companies, just like individuals, often use credit to
purchase goods and services to finance over short time periods. This
represents the interest on those short-term credit purchases to be paid.
 Dividends Payable: For companies that have issued stock to investors
and pay a dividend, this represents the amount owed to shareholders
after the dividend was declared. This period is around two weeks, so
this liability usually pops up four times per year, until the dividend is
paid.
 Unearned Revenues: This is a company's liability to deliver goods
and/or services at a future date after being paid in advance. This
amount will be reduced in the future with an offsetting entry once the
product or service is delivered.
 Liabilities of Discontinued Operations: This is a unique liability that
most people glance over but should scrutinize more closely.
Companies are required to account for the financial impact of an
operation, division, or entity that is currently being held for sale or has
been recently sold. This also includes the financial impact of a product
line that is or has recently been shut down.

Non-Current (Long-Term) Liabilities

Considering the name, it’s quite obvious that any liability that is not near-term
falls under non-current liabilities, expected to be paid in 12 months or more.
Referring again to the AT&T example, there are more items than your garden
variety company that may list one or two items. Long-term debt, also known
as bonds payable, is usually the largest liability and at the top of the list.

Companies of all sizes finance part of their ongoing long-term operations

by issuing bonds that are essentially loans from each party that purchases
the bonds. This line item is in constant flux as bonds are issued, mature, or
called back by the issuer.

Analysts want to see that long-term liabilities can be paid with assets derived
from future earnings or financing transactions. Bonds and loans are not the
only long-term liabilities companies incur. Items like rent, deferred taxes,
payroll, and pension obligations can also be listed under long-term liabilities.
Other examples include:

 Warranty Liability: Some liabilities are not as exact as AP and have to

be estimated. It’s the estimated amount of time and money that may be
spent repairing products upon the agreement of a warranty. This is a
common liability in the automotive industry, as most cars have long-
term warranties that can be costly.
 Contingent Liability Evaluation: A contingent liability is a liability that
may occur depending on the outcome of an uncertain future event.
 Deferred Credits: This is a broad category that may be recorded as
current or non-current depending on the specifics of the transactions.
These credits are basically revenue collected before it is recorded as
earned on the income statement. It may include customer
advances, deferred revenue, or a transaction where credits are owed
but not yet considered revenue. Once the revenue is no longer
deferred, this item is reduced by the amount earned and becomes part
of the company's revenue stream.
 Post-Employment Benefits: These are benefits an employee or family
members may receive upon his/her retirement, which are carried as a
long-term liability as it accrues. In the AT&T example, this constitutes
one-half of the total non-current total second only to long-term debt.
With rapidly rising health care and deferred compensation, this liability
is not to be overlooked.
 Unamortized Investment Tax Credits (UITC): This represents the net
between an asset's historical cost and the amount that has already
been depreciated. The unamortized portion is a liability, but it is only a
 rough estimate of the asset’s fair market value. For an analyst, this
provides some details of how aggressive or conservative a company is
with its depreciation methods.

Liabilities vs. Assets

Assets are the things a company owns—or things owed to the company—and
they include tangible items such as buildings, machinery, and equipment as
well as intangible items such as accounts receivable, interest owed, patents,
or intellectual property.

If a business subtracts its liabilities from its assets, the difference is its
owner's or stockholders' equity. This relationship can be expressed as
follows:

\text{Assets}-\text{Liabilities}=\text{Owner's
Equity}Assets−Liabilities=Owner’s Equity
However, in most cases, this accounting equation is commonly presented as
such:

\text{Assets} = \text{Liabilities} + \
text{Equity}Assets=Liabilities+Equity

Liabilities vs. Expenses

An expense is the cost of operations that a company incurs to generate
revenue. Unlike assets and liabilities, expenses are related to revenue, and
both are listed on a company's income statement. In short, expenses are
used to calculate net income. The equation to calculate net income is
revenues minus expenses.

For example, if a company has more expenses than revenues for the past
three years, it may signal weak financial stability because it has been losing
money for those years.

Expenses and liabilities should not be confused with each other. One is listed
on a company's balance sheet, and the other is listed on the company's
income statement. Expenses are the costs of a company's operation, while
liabilities are the obligations and debts a company owes. Expenses can be
paid immediately with cash, or the payment could be delayed which would
create a liability.

Example of Liabilities
As a practical example of understanding a firm's liabilities, let's look at a
historical example using AT&T's (T) 2020 balance sheet.1 The current/short-
term liabilities are separated from long-term/non-current liabilities on the
balance sheet.

AT&T clearly defines its bank debt that is maturing in less than one year
under current liabilities. For a company this size, this is often used as
operating capital for day-to-day operations rather than funding larger items,
which would be better suited using long-term debt.

Like most assets, liabilities are carried at cost, not market value, and
under generally accepted accounting principle (GAAP) rules can be listed in
order of preference as long as they are categorized. The AT&T example has
a relatively high debt level under current liabilities. With smaller companies,
other line items like accounts payable (AP) and various future liabilities
like payroll, taxes will be higher current debt obligations.

AP typically carries the largest balances, as they encompass the day-to-day

operations. AP can include services, raw materials, office supplies, or any
other categories of products and services where no promissory note is
issued. Since most companies do not pay for goods and services as they are
acquired, AP is equivalent to a stack of bills waiting to be paid.

How Do I Know If Something Is a Liability?

A liability is something that is borrowed from, owed to, or obligated to
someone else. It can be real (e.g. a bill that needs to be paid) or potential
(e.g. a possible lawsuit).

A liability is not necessarily a bad thing. For instance, a company may take
out debt (a liability) in order to expand and grow its business. Or, an
individual may take out a mortgage to purchase a home.

How Are Current Liabilities Different From Long-Term

(Noncurrent) Ones?
Companies will segregate their liabilities by their time horizon for when they
are due. Current liabilities are due within a year and are often paid for using
current assets. Non-current liabilities are due in more than one year and most
often include debt repayments and deferred payments.

How Do Liabilities Relate to Assets and Equity?

The accounting equation states that—assets = liabilities + equity. As a result,
we can re-arrange the formula to read liabilities = assets - equity. Thus, the
value of a firm's total liabilities will equal the difference between the values of
total assets and shareholders' equity. If a firm takes on more liabilities without
accumulating additional assets, it must result in a reduction in the value of the
firm's equity position.

What Is a Contingent Liability?

A contingent liability is an obligation that might have to be paid in the future,
but there are still unresolved matters that make it only a possibility and not a
certainty. Lawsuits and the threat of lawsuits are the most common
contingent liabilities, but unused gift cards, product warranties, and recalls
also fit into this category.

What Are Examples of Liabilities That Individuals or

Households Have?
Like businesses, an individual's or household's net worth is taken by
balancing assets against liabilities. For most households, liabilities will include
taxes due, bills that must be paid, rent or mortgage payments, loan interest
and principal due, and so on. If you are pre-paid for performing work or a
service, the work owed may also be construed as a liability.

************************************************
Equity for Shareholders: How It Works and
How to Calculate It
By
JASON FERNANDO

Updated July 05, 2022

Reviewed by
THOMAS BROCK
Fact checked by
KIRSTEN ROHRS SCHMITT

Investopedia / Katie Kerpel

What Is Equity?
Equity, typically referred to as shareholders' equity (or owners' equity for
privately held companies), represents the amount of money that would be
returned to a company's shareholders if all of the assets were liquidated and
all of the company's debt was paid off in the case of liquidation. In the case of
acquisition, it is the value of company sales minus any liabilities owed by the
company not transferred with the sale.

In addition, shareholder equity can represent the book value of a company.

Equity can sometimes be offered as payment-in-kind. It also represents the
pro-rata ownership of a company's shares.

Equity can be found on a company's balance sheet and is one of the most
common pieces of data employed by analysts to assess a company's
financial health.

KEY TAKEAWAYS
  Equity represents the value that would be returned to a company’s
shareholders if all of the assets were liquidated and all of the
company's debts were paid off.
 We can also think of equity as a degree of residual ownership in a firm
or asset after subtracting all debts associated with that asset.
 Equity represents the shareholders’ stake in the company, identified on
a company's balance sheet.
 The calculation of equity is a company's total assets minus its total
liabilities, and it's used in several key financial ratios such as ROE.
 Home equity is the value of a homeowner's property (net of debt) and is
another way the term equity is used.
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1:02

Equity

How Shareholder Equity Works

By comparing concrete numbers reflecting everything the company owns and
everything it owes, the "assets-minus-liabilities" shareholder equity equation
paints a clear picture of a company's finances, easily interpreted by investors
and analysts. Equity is used as capital raised by a company, which is then
used to purchase assets, invest in projects, and fund operations. A firm
typically can raise capital by issuing debt (in the form of a loan or via bonds)
or equity (by selling stock). Investors usually seek out equity investments as it
provides a greater opportunity to share in the profits and growth of a firm.

Equity is important because it represents the value of an investor's stake in a

company, represented by the proportion of its shares. Owning stock in a
company gives shareholders the potential for capital gains and dividends.
Owning equity will also give shareholders the right to vote on corporate
actions and elections for the board of directors. These equity ownership
benefits promote shareholders' ongoing interest in the company.

Shareholder equity can be either negative or positive. If positive, the

company has enough assets to cover its liabilities. If negative, the company's
liabilities exceed its assets; if prolonged, this is considered balance sheet
insolvency. Typically, investors view companies with negative shareholder
equity as risky or unsafe investments. Shareholder equity alone is not a
definitive indicator of a company's financial health; used in conjunction with
other tools and metrics, the investor can accurately analyze the health of an
organization.

Formula and How to Calculate Shareholders' Equity

The following formula and calculation can be used to determine the equity of
a firm, which is derived from the accounting equation:

\text{Shareholders' Equity} = \text{Total Assets} - \text{Total

Liabilities}Shareholders’ Equity=Total Assets−Total Liabilities
This information can be found on the balance sheet, where these four steps
should be followed:

1. Locate the company's total assets on the balance sheet for the period.
2. Locate total liabilities, which should be listed separately on the balance
sheet.
3. Subtract total liabilities from total assets to arrive at shareholder equity.
4. Note that total assets will equal the sum of liabilities and total equity.

Shareholder equity can also be expressed as a company's share capital

and retained earnings less the value of treasury shares. This method,
however, is less common. Though both methods yield the exact figure, the
use of total assets and total liabilities is more illustrative of a company's
financial health.

What the Components of Shareholder Equity Are

Retained earnings are part of shareholder equity and are the percentage of
net earnings that were not paid to shareholders as dividends. Think of
retained earnings as savings since it represents a cumulative total
of profits that have been saved and put aside or retained for future use.
Retained earnings grow larger over time as the company continues to
reinvest a portion of its income.

At some point, the amount of accumulated retained earnings can exceed the
amount of equity capital contributed by stockholders. Retained earnings are
usually the largest component of stockholders' equity for companies
operating for many years.
Treasury shares or stock (not to be confused with U.S. Treasury bills)
represent stock that the company has bought back from existing
shareholders. Companies may do a repurchase when management cannot
deploy all of the available equity capital in ways that might deliver the best
returns. Shares bought back by companies become treasury shares, and the
dollar value is noted in an account called treasury stock, a contra account to
the accounts of investor capital and retained earnings. Companies can
reissue treasury shares back to stockholders when companies need to raise
money.

Many view stockholders' equity as representing a company's net assets—its

net value, so to speak, would be the amount shareholders would receive if
the company liquidated all of its assets and repaid all of its debts.

Example of Shareholder Equity

Using a historical example below is a portion of Exxon Mobil
Corporation's (XOM) balance sheet as of September 30, 2018:

 Total assets were $354,628.

 Total liabilities were $157,797.
 Total equity was $196,831.1

The accounting equation whereby Assets = Liabilities + Shareholder Equity is

calculated as follows:

Shareholder Equity = $354,628, (Total Assets) - $157,797 (Total Liabilities) =

$196,8311

Image by Sabrina Jiang © Investopedia 2020

Other Forms of Equity

The concept of equity has applications beyond just evaluating companies.
We can more generally think of equity as a degree of ownership in any asset
after subtracting all debts associated with that asset.

Below are several common variations on equity:

 A stock or any other security representing an ownership interest in a

company.
  On a company's balance sheet, the amount of funds contributed by the
owners or shareholders plus the retained earnings (or losses). One
may also call this stockholders' equity or shareholders' equity.
 The value of securities in a margin account minus what the account
holder borrowed from the brokerage in margin trading.
 In real estate, the difference between the property's current fair market
value and the amount the owner still owes on the mortgage. It is the
amount that the owner would receive after selling a property and paying
any liens. Also referred to as "real property value."
 When a business goes bankrupt and has to liquidate, equity is the
amount of money remaining after the business repays its creditors. This
is often called "ownership equity," also known as risk capital or "liable
capital."

Private Equity
When an investment is publicly traded, the market value of equity is readily
available by looking at the company's share price and its market
capitalization. For private entities, the market mechanism does not exist, so
other valuation forms must be done to estimate value.

Private equity generally refers to such an evaluation of companies that are

not publicly traded. The accounting equation still applies where stated equity
on the balance sheet is what is left over when subtracting liabilities from
assets, arriving at an estimate of book value. Privately held companies can
then seek investors by selling off shares directly in private placements. These
private equity investors can include institutions like pension funds, university
endowments, insurance companies, or accredited individuals.

Private equity is often sold to funds and investors that specialize in direct
investments in private companies or that engage in leveraged
buyouts (LBOs) of public companies. In an LBO transaction, a company
receives a loan from a private equity firm to fund the acquisition of a division
of another company. Cash flows or the assets of the company being acquired
usually secure the loan. Mezzanine debt is a private loan, usually provided by
a commercial bank or a mezzanine venture capital firm. Mezzanine
transactions often involve a mix of debt and equity in a subordinated loan or
warrants, common stock, or preferred stock.

Private equity comes into play at different points along a company's life cycle.
Typically, a young company with no revenue or earnings can't afford to
borrow, so it must get capital from friends and family or individual "angel
investors." Venture capitalists enter the picture when the company has finally
created its product or service and is ready to bring it to market. Some of the
largest, most successful corporations in the tech sector, like Google, Apple,
Amazon, and Meta—or what is referred to as GAFAM—began with venture
capital funding.

Types of Private Equity Financing

Venture capitalists (VCs) provide most private equity financing in return for an
early minority stake. Sometimes, a venture capitalist will take a seat on the
board of directors for its portfolio companies, ensuring an active role in
guiding the company. Venture capitalists look to hit big early on and exit
investments within five to seven years. An LBO is one of the most common
types of private equity financing and might occur as a company matures.

A final type of private equity is a Private Investment in a Public Company

(PIPE). A PIPE is a private investment firm's, a mutual fund's, or another
qualified investors' purchase of stock in a company at a discount to the
current market value (CMV) per share to raise capital.

Unlike shareholder equity, private equity is not accessible to the average

individual. Only "accredited" investors, those with a net worth of at least $1
million, can take part in private equity or venture capital partnerships. Such
endeavors might require form 4, depending on their scale.2 For investors
who don't meet this marker, there is the option of private equity exchange-
traded funds (ETFs).

Home Equity
Home equity is roughly comparable to the value contained in
homeownership. The amount of equity one has in their residence represents
how much of the home they own outright by subtracting from the mortgage
debt owed. Equity on a property or home stems from payments made against
a mortgage, including a down payment and increases in property value.

Home equity is often an individual’s greatest source of collateral, and the

owner can use it to get a home equity loan, which some call a second
mortgage or a home equity line of credit (HELOC). An equity takeout is taking
money out of a property or borrowing money against it.
For example, let’s say Sam owns a home with a mortgage on it. The house
has a current market value of $175,000, and the mortgage owed totals
$100,000. Sam has $75,000 worth of equity in the home or $175,000 (asset
total) - $100,000 (liability total).

Brand Equity
When determining an asset's equity, particularly for larger corporations, it is
important to note these assets may include both tangible assets, like
property, and intangible assets, like the company's reputation and brand
identity. Through years of advertising and the development of a customer
base, a company's brand can come to have an inherent value. Some call this
value "brand equity," which measures the value of a brand relative to a
generic or store-brand version of a product.

For example, many soft-drink lovers will reach for a Coke before buying a
store-brand cola because they prefer the taste or are more familiar with the
flavor. If a 2-liter bottle of store-brand cola costs $1 and a 2-liter bottle of
Coke costs $2, then Coca-Cola has brand equity of $1.

There is also such a thing as negative brand equity, which is when people will
pay more for a generic or store-brand product than they will for a particular
brand name. Negative brand equity is rare and can occur because of bad
publicity, such as a product recall or a disaster.

Equity vs. Return on Equity

Return on equity (ROE) is a measure of financial performance calculated by
dividing net income by shareholder equity. Because shareholder equity is
equal to a company’s assets minus its debt, ROE could be considered the
return on net assets. ROE is considered a measure of how effectively
management uses a company’s assets to create profits.

Equity, as we have seen, has various meanings but usually represents

ownership in an asset or a company, such as stockholders owning equity in a
company. ROE is a financial metric that measures how much profit is
generated from a company’s shareholder equity.

What Is Equity in Finance?

Equity is an important concept in finance that has different specific meanings
depending on the context. Perhaps the most common type of equity is
“shareholders’ equity," which is calculated by taking a company’s total assets
and subtracting its total liabilities.

Shareholders’ equity is, therefore, essentially the net worth of a corporation. If

the company were to liquidate, shareholders’ equity is the amount of money
that would theoretically be received by its shareholders.

What Are Some Other Terms Used to Describe Equity?

Other terms that are sometimes used to describe this concept include
shareholders’ equity, book value, and net asset value. Depending on the
context, the precise meanings of these terms may differ, but generally
speaking, they refer to the value of an investment that would be left over after
paying off all of the liabilities associated with that investment. This term is
also used in real estate investing to refer to the difference between a
property’s fair market value and the outstanding value of its mortgage loan.

How Is Equity Used by Investors?

Equity is a very important concept for investors. For instance, in looking at a
company, an investor might use shareholders’ equity as a benchmark for
determining whether a particular purchase price is expensive. If that company
has historically traded at a price to book value of 1.5, for instance, then an
investor might think twice before paying more than that valuation unless they
feel the company’s prospects have fundamentally improved. On the other
hand, an investor might feel comfortable buying shares in a relatively weak
business as long as the price they pay is sufficiently low relative to its equity.

How Is Equity Calculated?

Equity is equal to total assets minus its total liabilities. These figures can all
be found on a company's balance sheet for a company. For a homeowner,
equity would be the value of the home less any outstanding mortgage debt or
liens.

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ARTICLE SOURCES

What is equity management?

July 28, 2020
Paige Smith

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Updated on September 1, 2020

Giving employees equity is more than a perk—it’s an investment in your

company’s success. At Carta, we believe equity is a fundamental employee right,
but it’s also a great way to attract and retain talent.
Managing your company’s equity, however, can be challenging. There’s a lot
that goes into it, particularly as your company grows.
What is equity management?
Equity management is the process of creating and managing owners in your
company. This may sound simple, but it involves everything from tracking and
reporting changes in ownership to updating documents, communicating with
stakeholders, consulting your board of directors, and staying compliant.
Equity management encompasses everyone’s experience—from equity
admins and outside investors to employee stakeholders and board members.
Let’s take a look at the process for each party involved:
Equity administration
Equity administrators are responsible for overseeing your equity system and
processes. They’re in charge of the following three areas:

Cap table management

A cap table is a record of all your company’s securities—including stock,
convertible notes, warrants, and equity grants—as well as who owns them.
The more securities your company issues, the more complex your cap table
tends to be.
An equity admin is responsible for issuing board-approved equity to
stakeholders, processing exercises and transfers, and updating your cap table
after a round of financing, liquidity event, or other material event. They also
send an updated version of the cap table to relevant stakeholders whenever a
change is made.

409A valuations
If you want to offer equity in your company, you may want to get an appraisal
called a 409A valuation to qualify for an IRS safe harbor. The purpose of
a 409A valuation is to determine the fair market value (FMV) of your common stock.
The valuation sets the price of a share.
You generally need a new appraisal every 12 months or whenever a material
event occurs. A material event is anything that could change the FMV of your
company’s stock, such as a qualified financing round, merger, or acquisition.

Maintaining compliance
A 409A valuation is one way to maintain compliance, but your equity admin
also has to help enforce set rules when issuing and reporting equity, including
abiding by Generally Accepted Accounting Principles (GAAP). In the U.S.,
part of that involves following ASC 718, a set of accounting standards that
outline the steps your company has to take when reporting employee stock-
based compensation on an income statement.
Accounting for expenses can be tricky, especially when you factor in new
valuations, ever-evolving accounting rules, and scaling for growth. If your
company issues equity to international employees, you have to address
International Financial Reporting Standards (IFRS) as well.
Many equity admins also review issuances against securities laws and
regulations, such as Rule 701 and the $100K ISO limit, and trace 83(b)
elections to accurately withhold taxes.
Stakeholders
Part of equity management involves updating your investors and employee
stakeholders on your company’s growth and finances. The more knowledge
and support your stakeholders have, the more likely they are to continue investing
in your company.
Keeping stakeholders in the loop requires time and technology. In addition to
issuing electronic certificates to stakeholders, you may also want to send
regular investor updates. Updates should include information about your
company’s trajectory, key metrics, hires, and customer wins. An update is also
a good place to spell out investor asks, whether you need more funding or
want help with an introduction.
Make sure you regularly update employee stakeholders as well. Keep in mind,
however, that updates aren’t the only step you should take. You also need to
give employees access to basic equity education, plus information on their
vesting schedule, PTE window, and the company’s performance. It may be
helpful to designate a point person employees can turn to to ask questions
about their equity.
Providing employees with continual support and offering fair, flexible equity
options can go a long way toward improving their experience at your
company.
Board members
Another crucial component of equity management: board management. You
typically need to get your board’s approval to issue equity, accept new rounds of
funding, and hire executives, all of which requires sharing sensitive
documents and providing updated cap tables and valuation reports.
Everyone
Managing equity also means managing liquidity options for everyone with
equity. Historically, it’s been difficult for employees to sell their private shares,
but many private companies are now realizing the value of offering liquidity
programs.
You can either hold a tender offer—which gives employees the opportunity to
sell their stock back to the company or to an investor—or allow employees to
sell their shares on a secondary transaction. Both transactions come with
either heavy paperwork or administrative costs. Plus, you have to update your
cap table each time there’s a change in ownership.
Fortunately, more options are becoming available to private companies. Later
this year, pending regulatory approval, we’ll be launching CartaX, our new
liquidity platform that will make it easier for private company employees to sell
shares and investors to buy them, while reducing the issuing company’s
administrative burden.
Why you should use one platform for equity management
Equity management isn’t as simple as updating your cap table—it
encompasses a variety of different people, processes, and tasks. As your
company grows and you continue to raise more money, equity management
can become even more complicated.
That’s why using one streamlined equity management platform can help. With
Carta, your cap table automatically updates after you issue grants. A single
equity management platform simplifies tedious (yet time-consuming) tasks,
like granting cap table access, getting approvals from board members,
running liquidity events, and sending investor updates.
 Carta also provides scenario modeling, which includes breakpoint and
sensitivity analysis as well as payout and dilution modeling. Modeling gives
you a better idea of how your company will respond to various changes like
investor exits, new rounds of fundraising, and shifting stock values.
When you use one equity management platform, you can:

o Lead the charge in creating more owners. An equity management platform
helps you stay organized, so you can spend less time on paperwork and more
time attracting new investors.
o Scale with ease. With one platform, all your equity and liquidity information is
connected and automatically updated, saving you time and money as you
grow.
o Be audit-ready all year. Equity management software helps you comply with
rules like the $100K ISO limit, so you never have to worry.
o Impress your stakeholders. Investors and employees can accept electronic
securities, track vesting schedules, model their potential tax obligation, and
exercise options in one central location.
o Get help whenever you need. At Carta, we pride ourselves on stellar
service. We’re always here to answer questions and help you make the best
decisions for your company.
Good equity management is critical to your company’s success. If you’re
considering offering equity or starting to build your company’s equity plan right
now, an equity management platform can help. See how Carta can help you
save time, support your stakeholders, and onboard new investors with ease.
DISCLOSURE: This publication contains general information only and eShares, Inc. dba Carta, Inc. (“Carta”) is not, by means of this
publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This
publication is not a substitute for such professional advice or services nor should it be used as a basis for any decision or action that
may affect your business or interests. Before making any decision or taking any action that may affect your business or interests,
you should consult a qualified professional advisor. This communication is not intended as a recommendation, offer or solicitation
for the purchase or sale of any security. Carta does not assume any liability for reliance on the information provided herein.

Paige Smith
Paige is a content marketing writer specializing in business, finance, and tech.
She’s written for a number of B2B industry leaders, including fintech
companies and small business lenders. See more of her work here.
What is Equity Management?
The equity of a company represents the amount of money the owners of a company
would have if they dissolved their business by selling their assets and paying off their
liabilities. Equity management is the process by which a company tracks and manages
the ownership of the company with relation to stakeholders.

What is Equity?
Equity represents the amount of money the owners of a company would have if a
company’s assets were liquidated, and its debt paid off in full. You can calculate
equities by subtracting the total liabilities from assets.

If the equity is positive, the company has enough assets to cover the total amount of
liabilities. If negative, you can deduce that liabilities are exceeding assets. It is optimal
to have the highest equity possible, and negative equity is a cause of concern. Overall,
equity of at least 50% of the total assets is ideal.

Liabilities
Liabilities are the factors that decrease a company’s equity. Think of liabilities as all the
things that reduce your company’s profit, like debt and taxes. Liabilities can be
categorized into two different groups: current liabilities and non-current liabilities.

Current liabilities represent money needed for operating expenses and debts payable
within one year, whereas non-current liabilities are the ones repaid over a longer period.
You should consider both current and long-term liabilities when calculating equity. What
we have mentioned above paints a not great picture of liabilities. However, it is also
important to keep in mind that while liabilities may decrease equity, they are essential
for rapid expansion and growth of a company.

The Pre-IPO Regulatory Checklist

LEARN MORE
Assets
The things that add more value to your company are called assets. To be more precise,
assets are elements that add economical value (either right now or in the future) to your
company. Assets aren’t necessarily monetary but can also appear as physical
equipment, real estate, or investments. Usually, assets will be listed on the balance
sheet amongst information of how they’re being financed.

There are two types of important business assets: namely current and fixed. Fixed
assets are non-current assets with a life of more than one year–typically plants,
equipment, and buildings. On the other hand, current assets are assets that can
immediately be turned into cash within a fiscal year. Current assets are cash and cash
equivalents, accounts receivable, inventory, and prepaid expenses.

What do Equity Administrators do?

Equity administrators are at the very backbone of equity management and are
responsible for handling equity management systems and processes that companies
have in place. Here is a list of responsibilities that equity administrators are required to
take care of:

Company Valuations (409a valuation)

It is imperative that a fair market price is determined for your company’s common stock
before offering equity to potential investors. You obviously wouldn’t want to sell yourself
short when raising funds, trying to exit your equity position. As such, equity
administrator perform a 409A valuation to determine the share price. This also serves
another purpose; it allows your company to qualify for an IRS safe harbor, in turn
reducing risk. It should be noted that a 409A is required to be completed on an annual
basis, or when a material event occurs.

Tracking Company Equity Transactions

Another one of the main tasks that equity administrators must take on is tracking all the
shares of the company issued to investors–who has been issued shares, who has sold
shares, etc. You should register this information in a safe place for future review and
reference.
Shareholder Management
It’s common sense that the more you know about something, the more you want to
invest in it. This philosophy applies to employees, potential investors, or current
shareholders. A substantial portion of equity management lies within updating
shareholders on the latest material information (any information that would impact a
shareholder’s decisions). Information can be disseminated in a variety of ways,
including quarterly reports, annual meetings, public announcements, emails, etc. The
only requirement is that the information be available to everyone at the same time–this
avoids potential insider trading.

Cap Table Management

Stock, equity grants, convertible notes, bonds, and warrants. The process of recording
all of these securities and who owns them is also known as cap table management. A
cap table (short for capitalization table) is a business evolution similar to a balance
sheet except with different elements involved. In general, cap tables will include
information such as shareholder info, rights to purchase equity, and the like–whereas
balance sheets display assets and liabilities. Learn more about cap table management
software to improve accuracy and reduce manual processes.

Maintaining Compliance
Companies in the United States are required to follow the Generally Accepted
Accounting Principles (GAAP) when it comes to financial reporting. The company
valuations, mentioned earlier, is a smaller subcategory of maintaining compliance. In
the United States, maintaining compliance also means following ASC 718–a set of rules
followed for reporting employee stock-based compensation. Other regulations may
apply against equity, and equity administrators must inspect all laws to withhold taxes
accurately.

Equity Management Software

Equity management software–also known as cap table management software –makes it
easier for a corporation to have an overview of the current status of its equity. Used by
businesses all over the world, equity management software executes some of the tasks
that are undertaken by equity administrators.
Some of the features offered in equity management software include equity issuance
and governance, cap table features, and growth/exit scenarios. Equity management
software helps free up more spare time for equity administrators and managers by
removing the process of involving legal teams for every issuance. Other key selling
points of equity management software are that it saves time, eliminates human error,
and reduces the cost of expensive personal reports.

Equity Management: Life Beyond the

Spreadsheet
WATCH WEBINAR

Digital/Electronic Equity and Asset

Management
Most companies, if not all, have transition to digital equity management. Digital equity
management software has many benefits over its archaic paper counterpart–information
is stored in a central location for everyone to view, updates are done in real time, and
reports can be generated on the fly at the click of a button. Your ERP, accounting, or
financial reporting software solutions may have equity management components built in
however these often come with significant limitations.

Digital equity management often links to digital asset management software. Though
the two are similar, the key difference is that digital equity management
software measures equity, and digital asset software measures assets. These types of
software pack all the information you need into a single program and make things much
easier to manage.

What is Shareholder Equity?

Otherwise known as stockholders equity, shareholder equity is essentially the same as
equity, except that it refers to a specific shareholder’s shares for a company. Some
other ratios and terms can be used to further analyze this shareholder equity–one
example would be return to equity (ROE), which refers to a company’s net income
divided by shareholder equity. This information can later be used to determine how
efficiently the equity is being used amongst investors for profit. You can find all the
information necessary to calculate a corporation’s equity on its balance sheet.

Shareholder equity is important for potential investors in terms of how they view a
business, in consideration of other factors. In general, negative equity would come
across as risky and potentially damaging, but this impression may be able to be
reversed with other metrics that demonstrate a more positive view of the company’s
progress.

Key Considerations for your 409A Equity

Valuation
WATCH WEBINAR

Examples of Equity Management

You may be confused thus far about the precise meaning of equity management. Here
are two examples that you can use to better comprehend the term.

Bill owns a highly successful donut business. He’s got approximately $10 million in
assets–including things such as brand reputation, property, equipment, etc. However,
he also has $3 million in liabilities. This would signify that Bill has total equity of $10
million–$3 million = $7 million. This first example results in positive equity, suggesting
that business is going well. If Bill liquidated all his assets and paid off his liabilities, he
would still have $7 million for himself.

Harriet, on the other hand, is struggling a bit with her business. She has obtained $3
million in assets whilst simultaneously accruing $4 million in liabilities. This would leave
her with total equity of $1 million, an example of negative equity. The negative number
signifies that work needs to be done to make Harriet’s business into a profitable one.
Harriet’s situation is sometimes referred to as a “balance sheet insolvency.”

The equity managers for Bill’s business might decide to invest a portion of his total
equity after carefully considering many factors. On the other hand, the equity managers
for Harriet might think of ways to recover her negative equity back to a positive one. In
either case, the final objective is to grow the equity as large as possible while
minimizing risks–something best analyzed using an equity management solution and/or
equity management services.

Financial Planning and Equity Management

Financial planning is the analysis of the monetary requirements of the corporation,
ranging from debts to sales and loans. Although this sort of planning is a year-round
activity, greater emphasis is placed on financial planning during the latter part of a
company’s fiscal year. (A fiscal year is a one-year period that a corporation uses for
financial reporting, budgeting, and taxation). This sounds great, but you are probably
wondering how financial planning ties into equity management, right?

Corporate financial planning will look at all of the financial aspects pertaining to a
company trying to achieve its goals. One of the major items that the financial planning
department looks at is funding growth. If a company has the cash flow to support
growth, that is great–but rarely the case. Most companies fund their growth through
equity financing (private placement or public stock offering) or by taking on debt. Both of
these options will have an impact on a company’s equity over the long term. Seeing as
financial planning ultimately ties back to information required to calculate your equity, it
should come as no surprise that most equity management software is packaged with
financial planning and reporting capabilities.

Equity Portfolio Management

Equity management and equity portfolio management are not the same thing, but they
are closely linked concepts. Both fields require substantial knowledge across equity
analysis and modern portfolio theory. You will often find active equity portfolio
management taking place in corporations that have excess shareholder’s equity. For
example, if your company is continually turning a profit, but not paying dividends out to
shareholders, it means that there is likely idle cash. Rather than reinvesting this money
into expansion, companies will often invest this money into other companies or bonds,
creating a need for portfolio management.
At the core of equity portfolio management lies the need to build a portfolio model. After
building a portfolio model, the manager will be able to calculate returns and evaluations.
This will then produce benefits in terms of efficiency and optimization. Equity portfolio
management can be sorted into further subsections, namely active and passive equity
management. The specifics of each of these subbranches of equity portfolio
management can be seen below.

Active and Passive Equity Management

There are two strategies used to create revenue on investment accounts, namely active
and passive equity management. These strategies further divide into subsections;
active equity management approaches can either be fundamental (discretionary) or
quantitative (systemic).

Fundamental active strategies are the ones that emphasize the role of human logic
when investing, whilst quantitative active strategies put rules-based models at a priority
when arriving at a decision. You can discern fundamental and quantitative approaches
using comparisons. If a type of management seems to place more importance on
personal judgment and is objective, the strategy is likely to be more fundamental than
quantitative.

Passive management is a type of management different from active management that

deals with investing strategies and important trades for portfolios. The main difference
between active and passive equity management is that active requires a higher level of
buying and selling to get past a specified benchmark, whereas the purpose of passive
equity management is to create a return that is the same as the chosen index.

Recap
In this article, many aspects of equity management have been discussed. To recap, the
fundamental reason why equity management is undertaken is to make sure that a
business is using its equity efficiently and ensuring owners have their appropriate stake
in the business. You can calculate equities by subtracting the total liabilities from assets.
 Equity administrators are the people responsible for keeping track of equity. They
complete various tasks with the aid of equity management software–programs that
display the current equity status–and take care of legal implications. Shareholder’s
equity is a form of equity that refers to a shareholder’s stake in a company and financial
planning is the analysis of the monetary requirements of the corporation, ranging from
debts to sales and loans.

Hopefully, this article has given you a strong fundamental understanding of equity
management and how equity management software can help your company. If you
have any question about equity management software, please contact us.

https://eqvista.com/equity/equity-management/

The risk management process

Businesses face many risks, therefore risk management should be a central part of any business'
strategic management. Risk management helps you to identify and address the risks facing your business
and in doing so increase the likelihood of successfully achieving your businesses objectives.

A risk management process involves:

 methodically identifying the risks surrounding your business activities

 assessing the likelihood of an event occurring
 understanding how to respond to these events
 putting systems in place to deal with the consequences
 monitoring the effectiveness of your risk management approaches and controls
As a result, the process of risk management:

 improves decision-making, planning and prioritisation

 helps you allocate capital and resources more efficiently
 allows you to anticipate what may go wrong, minimising the amount of firefighting you have to do or, in a
worst-case scenario, preventing a disaster or serious financial loss
 significantly improves the probability that you will deliver your business plan on time and to budget
Risk management becomes even more important if your business decides to try something new, for
example launch a new product or enter new markets. Competitors following you into these markets, or
breakthroughs in technology which make your product redundant, are two risks you may want to consider
in cases such as these.
 The types of risk your business faces
The main categories of risk to consider are:

 strategic, for example a competitor coming on to the market

 compliance, for example the introduction of new health and safety legislation
 financial, for example non-payment by a customer or increased interest charges on a business loan
 operational, for example the breakdown or theft of key equipment

https://www.infoentrepreneurs.org/en/guides/manage-risk/