Trading on Equity is an economic strategy. Companies procure debts in the forms of loans, bonds, debentures etc. So, in another word, we can say that with the new assets, companies try to increase their income. The additional income which is coming from the company increases earnings per share for the shareholders. This is an indication which states that it is fruitful. However, there are many losses also. So whatever you will do, just keep in mind and then proceed. Those who are from commerce backer can get an idea, but those who are from different backgrounds might face a problem in understanding all the terms which are there.
We will discuss the types of trading on equity.
Trading on equity can also be termed as financial leverage. We can conclude that a company uses the equity strength to get the debts from the creditors. Let's discuss the two types of trading on equity.
Trading on thin equity: In this case, a company leases a large sum of money and it is more important if we compare it with equity strength.
Trading on thick equity: In this case, the company obtains a fund that is reasonable and fair in comparison to equity strength.
The manager of the company measures the effects of trading in two types of metrics.
● Capital Gearing Ratio: It is measured by the addition of adventures and preference capital. The sum total is divided by the equity of the shareholders.
Debentures+Preference Capitals/Equity of the Shareholders.
The trading on equity refers to capital gearing.
● Degree of Financial Leverage: It is expressed in the change in percentage in EPS divided by change in percentage in EBIT.
%change in EPS/ %change in EBIT.
Let us discussed this matter by giving a suitable example.
Bajaj Limited decided to finance an expansion. It is anticipated that the current capital structure consisted of approximately Rs 5 lakhs as an equity income. It is believed that another Rs 5 lakhs are needed for this. In this case, what will the manager of the Bajaj Limited do? Let us see.
- Allotment of common shares which worth Rs. 5 lakhs.
- Allocation of common shares which worth Rs.2 lakhs and the rest sum of money will be procured at least by 5% debt. The whole percentage by procurement of 8% debt.
- Allocation of common stocks which worth Rs.2 lakhs and the rest amount by issuing 5% preference shares.
Advantages of Trading on Equity
There are two types of advantages of trading on equity.
- Tax/Fund Factor
Taxation is one of the key factors for the best source of financing. This is the reason for selecting debt capital. The interest that is coming on the debt before the rebates on surcharge is an outlay that is accounted for. It is also beneficial for reducing the tax liability of the overall company.
- Debt-servicing cost
Lower debt servicing factor is also one of the critical advantages. Let me give you an example of a company obtaining 20% debentures and 20% preference shares, it will earn a pre-tax income of Rs 20 per Rs 100 for the debt service. But Rs 40 per Rs 100 to service the preference share.
We have discussed the advantages of trading on equity. In every marketing department, there are advantages as well as disadvantages. There are too many risk factors also. Keeping in mind that thing, we have to proceed. We can conclude that trading on equity is much more useful to enhance the value of shareholders.
Disadvantages of Trading Equity
There are disadvantages also. Let us discuss it.
- One of the most critical drawbacks of trading equity is that you are not certain whether the business where you have invested your money will be proficient to serve debt or not. There is always a big question.
- Another disadvantage is if the principal amount and the leased amount are not down at a convenient level then it can be threatening for your business. You can lose your money.
- The interest burden can also increase if the interest rates rise in servicing debt.
- There will be a huge loss and you can be bankrupt also.
Don't panic for the disadvantages as there are also certain ways by which you can resolve this problem.
So, here we have discussed the benefits as well as the drawbacks. Now reading this article, you have to decide if trading on equity is beneficial or not.
The distinction between Equity in trade and trading equity.
Now, we will discuss the distinction between trade on equity or trading on equity.
Many of us often get confused about these two phrases and consider those to be similar.
However, these two terms are completely different from each other.
As said before, trading on equity is a financial strategy which helps in growing the earning of the shareholders. Equity trading is different and is related to selling and buying of stocks.
The manager of the company executes and performs all the tasks of trading on equity. On the other hand, any individual can handle equity trading.
There are more differences between equity trading and trading on equity. People should know the basic differences as many of them think these two to be similar. J hope all of you got your idea.
Conclusion
In today's era, we have progressed a lot in terms of technology. You can easily get all the information if you google it.
If you are a beginner, then it is quite natural that you will not know the exact terms and the conditions involved in trading equity. Many people with zero knowledge come to invest their money and at the end of the year, they meet up with a heavy loss. Nobody wants to lose their money as it is hard-earned. So, this article will help you as we have given all the relevant information by which you can get an idea and then only you can decide your mind.