Negative equity refers to a situation where the total liabilities of a company exceed its total assets, resulting in a net deficit in shareholders’ equity.
In other words, the business has more financial obligations and debts than the value of its assets. Negative equity can pose significant challenges for a company and may indicate financial distress.
Equity is calculated using the following formula:
Equity = assets − liabilities
If the result is negative, it indicates negative equity.
Several factors can contribute to negative equity, including:
Negative equity can have several implications for a business:
Companies with negative equity may implement turnaround strategies to improve their financial position. This may involve cost-cutting, restructuring, debt renegotiation, or other measures to increase profitability and reduce liabilities.
Negative equity can adversely affect how the market perceives a company. Investors and stakeholders may view it as a sign of financial instability, impacting the company’s stock price and credit rating.
Company XYZ, a manufacturing firm, has total assets worth R500,000, including equipment, inventory, and cash. However, the company has outstanding liabilities totalling R600,000, including loans, accounts payable, and other debts.
Using the formula for equity:
Equity = R500,000 – R600,000 Equity = -R100,000
In this example, Company XYZ’s equity is negative R100,000. This indicates that the company’s liabilities exceed its assets, resulting in negative equity.