Profit and equity are key elements of modern business finance that deal with business investment. Although, at first glance, these terms may appear interchangeable, they actually refer to unique elements of finance. Understanding the features and differences allows investors to evaluate the profit- and equity-sharing aspect of an enterprise before staking hard-earned cash.
Defining Profit and Equity Share
Profit share refers to the portion of a company's income that goes to its owner and investors. Equity share pertains to the size of ownership interest held by an investor or business owner.
For example, investor A bought 100 shares of stocks from XYZ Company and received a share of $1,000 from dividends declared within the year. Investor A's equity share is equivalent to 100 shares of stocks, and his profit share is $1,000.
Although both the profit share and equity share are directly related to one another, each term refers to a different 'side' of the transaction, be it the number of shares purchased or the profit derived from dividends dispensed to shareholders.
Results of Business Activity
Profit share and equity share are the results of different types of business activities. Equity share is the result of investing money into a business such as when establishing a new company or when buying stocks of a publicly traded corporation. Profit share is derived from results of overall business operations, such as a business partner receiving a portion of profits earned from manufacturing products.
Relationships Between Them
Profit share is directly proportional to equity share. This means that a higher equity share will yield a higher profit share. Simply put, if you decide to acquire a higher number of shares, you will derive greater financial benefit during profit share than those who acquired fewer shares. The greater risk an investor takes in acquiring shares, the greater the reward in the event of rising share value.
In accounting, the efficiency of equity to generate profits can be measured and compared using a financial analysis tool called return on equity, or ROE. This ratio is computed by dividing profits by total equity.
How They're Calculated
Profit share is time-specific. Its monetary value changes according to the accounting period being taken into consideration when preparing an income statement. Equity share is not directly affected by accounting periods, but it is directly affected by various financial activities such as dividend payments, issuance and retirement of stocks, gains and losses from operations, and capital expenditures.
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