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“The Knowledge Library”

Knowledge for All, without Barriers…

An Initiative by: Kausik Chakraborty.
03/06/2023 11:44 PM

“The Knowledge Library”

Knowledge for All, without Barriers……….
An Initiative by: Kausik Chakraborty.

The Knowledge Library

Difference between Equity and Preference Shares

Accountancy is a vivid branch of commerce that deals with shares, stocks, financial and non-financial information. In simple words, accountancy is defined as the process of keeping track of financial transactions regarding a corporation or a business. Many chartered accountants record financial transactions through summarizing, reporting, and analyzing. Well, there are several types of accounting like tax accounting, financial accounting, auditing, managerial accounting, etc. Now, one of the major parts of accountancy is the shares, i.e., Equity and Preference shares. These shares hold a lot of importance in buying and selling. So, let us know the basic meaning of these shares.

Equity Shares

Equity shares are defined as the shares that are issued to the general people which are non-redeemable. Equity shares are also known as long-term financial sources. The investors who invest in these equity shares have the right to vote and share the assets and the profits of the company. There are various types of equity shares like issued shares, subscribed shares, authorized shares, etc. One of the main characteristics of equity shares is that the management of the company is selected but the shareholders. Some of the examples of equity shares include preferred stock, common stock, treasury stock, etc.

Preference Shares

Preference shares are also known as preferred shares/ stocks. In preferred stocks, the shareholders get the dividends declared by the company on a priority basis. A dividend is defined as the return on investment upon a particular amount (profit). The preference shareholders get priority over the equity shareholders as the dividend is first divided among the preference shareholders, and then it is divided among the equity shareholders. The distribution percentage is already decided by the company, also known as the proposed dividend. For instance, if the company earned a profit of 5 crores, then the preference shareholders earn a fixed percentage of their preferential holdings of the profit. The dividend, which is to be divided among the equity shareholders, is prescribed/ announced by the company every year (proposed dividend).

Now, let us look at some points of contrast between the equity and preference shares.

EQUITY SHARES PREFERENCE SHARES
Equity shares are the shares that are issued to the general public. These shares are non-redeemable. On the other hand, preference shares are the shares in which the dividends are distributed among the shareholders declared by the company.
Equity shareholders have the right to vote and have a share in the assets and profits of the company. Preference shareholders do not enjoy such rights.
Equity shares are also known as long-term financial sources. Preference shares are commonly called as preferred stocks.
The dividend is paid to the equity shareholders after all the liabilities have been paid off. In preference shares, the dividend is the priority of the company.
If the company is closing due to any reason, equity shares are repaid. On the other hand, the preference shares are repaid first rather than the equity shares when a company is closing.
The percentage of dividends in equity shares is constantly fluctuating. The percentage of dividends in preference shares is permanently fixed.
Equity shares are non-redeemable. Preference shares are redeemable.
The shareholders have the right to vote in equity shares. In exceptional situations, preference shareholders enjoy voting rights; otherwise, they do not have the right to vote.
Equity shares cannot be transformed. On the other hand, preference shares can be converted into equity shares.
Equity shareholders do not get any loan on the dividends for previous years. On the other hand, preference shareholders get loans on the dividends for previous and present years.
Equity shares and shareholders are responsible for the management of the company. Preference shares or shareholders are not responsible for the management of the company.
There are several types of equity shares. They are:

  • Issued Shares
  • Subscribed Shares
  • Authorized Shares, etc.

So, these are the significant points of contrast between equity shares and preference shares. Both equity and preference shares are essential for the company. Now, let us look at some of the advantages and disadvantages of both the shares.

Advantages of Equity Shares

  1. In equity shares, there is no pressure on the company to pay the fixed rate of dividend.
  2. Equity shares are issued without any charge on the company’s assets.
  3. Equity shares are the long-term financial sources of the company, and the company has to repay them under liquidation.
  4. Equity shareholders are considered to be the owners of the company as they have voting rights.
  5. In equity shares, if the profit is more, then the taxes charged will be less.

Disadvantages of Equity Shares

  1. In equity shares, the company is not able to yield any profit in trading.
  2. As the capital provided by the equity shares cannot be redeemed, there is a risk of over-capitalization.
  3. Since equity shareholders elect the management of the company, they can easily manipulate and influence the organization/ company.
  4. When the company earns profits, higher dividends are paid to the shareholders. This leads to speculation in the company.
  5. The investors who want to invest in safe securities, equity shares are not for them.

Advantages of Preference Shares

  1. In preference shares, there is no compulsion on the company to pay the dividends. In preference shares, the dividend is not a fixed liability.
  2. The borrowing capacity of the company is increased in preference shares as the debt is reduced to equity.
  3. The preference shareholders do not get any voting rights. So, there is no dilution of equity shareholders.
  4. In preference shares, the company is able to get the required money and assets. There is no charge for assets or capital on the company.

Disadvantages of Preference Shares

  1. The preference shares are very expensive financial sources of the company. The tax rates on loans are quite high in preference shares.
  2. When the preference shareholders are not paid the dividend, it might not be right for the image of the company. Therefore, the company must pay the dividend to the preference shareholders as well.
  3. Preference shareholders have the same situation as that of equity shareholders, but still, they do not enjoy the right to vote or elect the management of the company.

So, these are some of the advantages and disadvantages related to equity shares and preference shares. Well, both equity and preference shares have a lot of advantages. But it is interesting to note that the preference shares do not exist in India. People in India can only invest in equity shareholders. Preference shares exist in various other countries, except India. Both equity and preference shares have several differences that have already been given above. Thus, both equity and preference shares are essential for a company’s smooth and efficient functioning.

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