The shareholders’ equity is a figure that helps to indicate the health of your business. In simple terms, it represents a measure of whether this business has enough assets to meet any liabilities that it might face. Because of this, the shareholders’ equity can be either positive or negative. If it is negative, this means that the business would have nothing left if all assets are liquidated and all debts paid. However, if the shareholders’ equity formula produces a positive figure, it means that the total assets held by the business exceed all liabilities.
The impact of negative shareholders’ equity
If a business has negative shareholders’ equity it could mean it represents something of a risk, because if all of the assets in the business have to be liquidated they will not generate enough income to pay all of the current debts. In such a situation, it is likely investors will be wary of putting money into the business, because shareholders will be left with nothing once debts have been paid.
The shareholders’ equity formula can also be used to calculate the ratio between the investment pumped into a business over a certain period, and the return which that investment has helped to generate.
How to calculate equity
All of the information needed to complete the shareholders’ equity formula is available on the balance sheet of a business, in terms of the assets and liabilities. The asset calculation will be based on a combination of current and noncurrent assets:
Current assets – assets that could be converted into cash within a short period of time such as a year. Items counted as current assets might include cash held by the business, stock and accounts receivable.
Non-current assets – these are assets that will generate benefits for the company over a period of more than 12 months. Examples could include buildings owned by the business, vehicles and ongoing trademarks.
The liabilities used for calculating shareholders’ equity are divided along the same lines:
Current liabilities – debts that must be paid within 12 months
Long term liabilities – debts that are due after more than 12 months
The shareholders’ equity formula
There are two formulas that can be used to calculate the shareholders’ equity. The first of these formulas is:
Shareholders’ Equity = Total Assets – Total Liabilities
This is sometimes called the “basic accounting equation”, and is fairly simple. All it requires is to take the sum of assets on the balance sheet and deduct the liabilities on the same balance sheet. In simple terms, the amount that remains after the total liabilities are deducted from the total assets is the amount that shareholders would receive if all assets were liquidated and all debts paid.
The second formula for shareholders’ equity is:
Shareholders’ Equity = Share Capital + Retained Earnings – Treasury Stock
This formula is sometimes known as the investor’s equation. It takes the retained earnings of the business and the share capital and deducts any treasury shares. The retained earnings are the earnings of the business built up after dividends have been paid to shareholders. The figure can be found in the shareholders’ equity part of the balance sheet. Treasury stocks are shares in the business that have been repurchased to potentially be sold on to investors.
We can help
Calculating shareholders’ equity can help you to monitor the wider health of your business, but it only works if you can rely on the money coming in through customer payments. Partnering with a payment platform like GoCardless keeps this process as simple as possible, and this includes the more complex aspects such as dealing with ad hoc payments or recurring payments.