How do a company’s shareholders evaluate their equity in the business? Shareholder or stockholders’ equity is one simple calculation to pay attention to. Here’s what you need to know about how to calculate stockholders’ equity.
What is shareholders’ equity?
Shareholders’ equity (SE) is also known as stockholders’ equity, both with the same meaning. This term refers to the amount of equity a corporation’s owners have left after liabilities or debts have been paid. Equity simply refers to the difference between a company’s total assets and total liabilities.
There are several components that go into shareholder equity, including retained earnings. This is the percentage of net earnings left over after dividends have already been paid. It’s important to note that retained earnings are separate from liquid assets like cash, but still make up a portion of the total assets for equity purposes.
How to calculate stockholders’ equity
The stockholder or shareholders’ equity formula is straightforward:
Shareholder Equity = Total Assets – Total Liabilities
Total Assets will include all current and noncurrent assets. Current assets are generally liquid, or those which could be easily converted into cash in the short term, such as accounts receivable and inventory. Long-term assets include intangibles like intellectual property and patents, along with property, plant, and equipment (PPE) and investments.
Total Liabilities also include both long and short-term entities. Current liabilities would include debts that must be repaid within the year, such as taxes and accounts payable. Long-term liabilities include debts that can be repaid over time, along with obligations like leases and pension payments.
Both total assets and total liabilities will be listed on the balance sheet.
The shareholders’ equity formula is the same as the accounting equation, which forms the foundation of a company balance sheet. It applies here as well. To calculate shareholders’ equity, use the following steps.
Find the total assets for the accounting period on the balance sheet.
Add together all liabilities, which should also be listed for the accounting period.
Subtract the liabilities from the assets to reveal the total shareholders’ equity.
There is a second way to calculate stockholders’ equity when the balance sheet is unavailable. This method adds together the total capital paid for shares, plus donated capital and retained earnings. This equation is often called the “investors’ equation”:
Shareholders’ Equity = Share Capital + Retained Earnings – Treasury Shares
Share capital includes all contributions from the company’s stockholders to purchase shares in the company. Retained earnings are the accumulated profits, or business earnings minus dividends paid out to shareholders. Treasury shares are those that have been issued by the company but then later repurchased. These must be deducted from stockholders’ equity, as they’re owned by the company.
Why is shareholders’ equity important?
The SE is an important figure to be aware of, primarily for investment purposes. When shareholders’ equity is positive, this indicates that the company has sufficient assets to cover all of its liabilities. However, when SE is negative, this indicates that debts outweigh assets. If the shareholders’ equity remains negative over time, the company could be facing insolvency.
Shareholder equity can also indicate how well a company is generating profit, using ratios like the return on equity (ROE). This shows you the business’s net income divided by its shareholder equity, to measure the balance between investor equity and profit. It’s used in financial modeling to forecast future balance sheet items based on past performance.
Although shareholder equity isn’t the only factor to consider when weighing up an investment, if it’s negative, the company’s prospects are far riskier. You can use this figure in conjunction with other metrics of financial health to form your analysis.
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