Types of Shares Explained
We have often heard about the term ‘shares’ in the financial sector. The definition of the term share lies in the word itself. But we may not know about the term in detail. A share, in the finance market, means a unit used as limited partnerships, mutual funds, and real estate investment trusts. A person who holds the share(s) in a particular company is known as the shareholder of the organisation. In a further technical term, a share is a unit of capital that cannot be divided and it expresses the ownership relationship between the shareholder and the corporation. Everything about shares is not an easy task to understand. For this purpose, we have to understand the basics of the equity shares and preference shares only, in detail.
Equity Shares
The other name of ‘equity share’ is ‘ordinary share’. It is a subset under the fractional ownership or part ownership in which the shareholder tackles the maximum business risk as a fractional owner. Generally, the members of the company with voting rights are the holders of Equity Shares. Long-term capital is raised with the aid of Equity shares. Equity shareholders are called ‘residual owners’. They are paid the residual amount after the settlement of claims on the company’s income and assets. These shareholders can take part in the management of the company through their voting rights.
Advantages of Equity Share
Equity capital is the building block of a company. It is the last thing added in the list of claims and it produces a cushion for creditors.
Equity capital generates creditworthiness to the company and boosts up the confidence of various loan producers.
Equity shares are preferred by investors who are willing to take larger risks.
It is not compulsory to pay the dividend to the equity shareholders. So, the company will not face any burden for this.
The funds are raised by equity issues without generating any charge on the assets of the company.
The management of the company may be controlled by the equity shareholders by their voting rights.
Disadvantages of Equity Shares
Risk-averse investors with the preference of fixed income will not like equity shares.
The cost of raising funds from other sources is lower than the cost of equity shares.
The voting rights and earnings of existing equity shareholders are dismissed by the issue of the additional equity shares.
Equity share is a time-consuming process as it involves various formalities and administrative delays.
Preference Shares
Preference Shares are the shares which guarantee the holder a fixed and steady dividend, whose payment takes priority over the equity share dividends. Capital raised by the issue of preference shares is termed as preference share capital.The basic difference between preference shareholder and equity shareholder is that preference shareholders are in a better position over the equity shareholders. Preference shareholders receive a fixed and steady dividend from the revenue of the company before an equity shareholder gets any dividend.
Types of Preference Share
There are three types of preference shareholders namely Cumulative and Non-Cumulative, Participating and Non-participating and Convertible and Non-Convertible.
a) Cumulative and Non-Cumulative
Cumulative preference shares are known as the preference shares that have the power to collect dividends which are not paid in the future years, in case the same is not paid during a year. If the dividend is not accumulated over the unpaid dividends in a particular year it is called Non-cumulative shares.
b) Participating and Non-Participating
Preference shares which have the power to take part in the extra surplus of company shares which, after dividend, is paid at a fixed rate on equity shares are called participating preference shares. In the case of non-participating preference shares, the above power is not exercised.
c) Convertible and Non-Convertible
If the preference share is converted into equity shares for a certain period of time, it is called convertible preference share. The rest is called non-convertible preference shares.
Advantages of Preference Share
1. It does not influence the control of equity shareholders over the management.
2. There may be a hike in dividend for the equity shareholders in the good time.
3. The income of the shareholders is steady and fixed.
4. They have a preferential power of repayment over the equity shareholders.
5. Any sort of charge against the assets of a company is not created by the preference capital.
Disadvantages of Preference Share
The amount dividend is higher than the rate of interest on debentures.
The dividend on these shares is regulated by the revenue of the company.
Risk lovers will not prefer this kind of share.
Claims of equity shareholders diluted by the preference capital.
It is not possible to deduct the dividend paid from the profits as an expense.
So, in a nutshell, shares of certain companies are based on two types of shares namely equity shares and preference shares. Both the shares are equally important in respect of shareholders of companies and both of them have certain merits and demerits.
Quick Hacks to Test your Knowledge on Equity Shares and Preference Shares Incorporating Vedantu
A student must be thorough with equity shares as well as preference share by understanding the basic concepts related to this topic. In order to make it convenient for the students, here are listed the differences between equity share and preference–
Preference shares can be transformed into equity shares but equity shares can not be transformed or changed into preference shares.
On the basis of Dividends, equity shareholders do not get fixed dividends while preference shareholders have fixed dividend payout who receive the dividends before equity shareholders.
Equity shareholders have the right to vote in the company meetings while preference shareholders enjoy no such votes in the company annual meetings.
The rate of dividend received by the equity shareholders can fluctuate based on the turnovers and profits of the company while preference shareholders enjoy fixed payout on dividends.
Upon winding up of company and liquidation of company assets, preference shareholders receive repayment of capital while equity shareholders do not.
Upon understanding the difference between them both, a student can understand the advantages and disadvantages of both of the types of shares deeply. It will surely come in handy during preparing for exams.
The objective of Financial management
A student must understand the importance of financial management since it is an essential concept in Commerce. Here are a few points that explain that throws some light on the objectives of finance management–
Financial management delves primarily into maximising the shareholder’s wealth corresponding to the current market rates of equity shares. The wealth can be optimised upon optimum utilisation of present funds.
The cost has to be minimized and in order to achieve that, the funds should be acquired at the lowest minimum price and rate so that the financial planning can come to successful fruition.
The composition of capital must be a perfect balance between funds and debts.
The returns must always exceed the investment so as to optimize the utilization of the funds which in return makes the utilization more effective and efficient.
The investment must be safe and free of risks so that the plan works in favor of shareholders in maximizing their returns.
Students can find the notes of Equity shares and Preference shares from Vedantu’s official website as well as the mobile application. The solutions to questions on textbooks of Class 11 and 12, sample questions as well as practice papers can also be found and downloaded in PDF formats.
Incorporating Vedantu on a regular study schedule can be beneficial for a student in terms of understanding Equity shares and Preference shares. Live sessions, as well as doubt clearing sessions, are available for students’ ease and convenience.
The basic concepts and textbook solutions to the Equity Shares and Preference Shares chapter are also available on the Vedantu e-learning platform that will surely help the students who are looking for an easy understanding of this topic and make notes for exams.
To better understand this topic, a student may also indulge in understanding the market practices and learn from the experts regarding the investment policies as well as stock market practices to make it more elaborate in terms of understanding the shares and investment behind it.
A student must study this topic regularly and understand the differences between both of the shares in order to clear the basic concepts and prepare for the exams with more agility and confidence.
Summary on Equity and Preference Shares
Equity shares and Preference shares are one of the core topics in a basic understanding of commerce that must be taken seriously but they must be understood along with the concepts of capital structure.
Capital structure is the blend of equity funds and debts that results in total capital. Some of the factors of capital structure that centre around equity and preference shares are listed below for a quick reference–
Cost of equity
Floatation cost
Cost of debt
Considering risks (Financial risks and operating risks)
Stock market conditions (Bullish phase and Bearish phase)
Cash flow position
High and low return of investment
A student must prepare notes and pay minute attention to the definitions and explanations of the concepts without neglecting the advantages and disadvantages of equity shares and preference shares. Writing them down also helps in memorising them.
A student can refer to the visual concepts and interactive sessions that are available over Vedantu. It is helpful for the students to recall the answers later during examinations.
The solutions regarding equity shares and preferences that are available over Vedantu’s website are curated for easy understanding of the concepts and can be downloaded for incorporating the notes and solutions for revision.
The sample papers have proven to be essential for scoring better marks in the exams, however, textbooks are just as important so a student should pay attention to both of them.
