What is stockholders' equity? (With definition and examples)
By Indeed Editorial Team
Published 21 November 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Stockholders' or shareholders' equity is the amount of money an organisation still holds after clearing any liabilities and paying off all debts. It also amounts to the organisation's net worth, and all the money belongs to the owners. It's a useful tool to use alongside other metrics if you want to learn about an organisation's financial health. In this article, we discuss what stockholders' equity is, explain how it works and look at an example of it in use.
What is stockholders' equity?
Stockholders' equity is the value of all assets owned by an investor after settling any liabilities. It's a similar concept to owner's equity, but it focuses on the value of an organisation rather than the owner's assets. Shareholders' equity is a useful tool for measuring the financial health of an organisation as it allows you to assess the funds held within it. If the value is negative, it points to poor financial performance and the possible risk of bankruptcy. A positive value denotes strong financial health and performance.
What goes into shareholders' equity?
Several components go into shareholders' equity, which are all found on the organisation's balance sheet. These figures include:
Paid-in capital: Paid-in capital is any funding the organisation holds from investors when dispensing shares of either common or preferred stock.
Retained earnings: Retained earnings are the organisation's total profits after deducting dividends to any shareholders.
Accumulated other comprehensive income: This includes any revenue or expenses that don't factor into the net income on the income statement.
Treasury stock: Treasury stock includes any outstanding shares of stock that an organisation buys back from shareholders.
Preferred stock: Preferred stock includes any stock where dividends hold the most significance. This means shareholders receive dividends and payments before common stockholders.
Common stock: Common stock includes any shares representing corporate ownership of the organisation.
How do you calculate shareholders' equity?
To calculate shareholders' equity, look at the formula below:
Total company assets - total company liabilities = shareholders' equity
You may also calculate the shareholders' equity by deducting the share capital and retained earnings from the treasury stock. Use the following formula as a guide for this:
Share capital + retained earnings - treasury stock = shareholders' equity
Where do you find the information to calculate shareholders' equity?
All of this information is typically on the organisation's balance sheet. From here, it's just a matter of understanding the definitions and what they entail. Total assets include all current and noncurrent assets. Current assets, such as earnings, have the ability to become cash after one year, but noncurrent ones, like property, can't.
Other useful terms to understand are total liabilities and current liabilities. Current liabilities include any debts that require repayment within one year, such as taxes. Long-term liabilities, such as property leases, have repayments that extend beyond a year. Once you determine the total assets and liabilities, you're ready to calculate the shareholders' equity.
How do treasury shares impact shareholders' equity?
When an organisation can't allocate enough equity capital to create enough profits, it might choose to return some of the shareholders' equity to stockholders. This form of reverse-capital exchange is known as a share buyback.
Any shares bought back by an organisation are treasury shares. Treasury shares fall under the category of issued shares, but they aren't outstanding shares. Therefore, they don't factor into dividends or when calculating earnings per share. An organisation may reissue treasury shares for stockholders to purchase when it requires more capital. The organisation might wish to retire the shares if they don't want to hold onto them.
Examples of shareholders' equity
To help you understand shareholders' equity in a real-world context, take a look at the following examples:
A wealth management firm has accumulated assets of £3 million and liabilities totalling £2 million. The shareholders' equity for the organisation is £1 million, which you find by deducting the liabilities from the assets. The £1 million figure is the total amount that stockholders have available to them after paying off all debts and liabilities. The firm's balance sheet reports on the shareholders' equity and breaks down each part of it, including common stock, preferred stock and other components.
A young entrepreneur sells drawings online. They have £100 in assets every week and £40 in liabilities. Their shareholders' equity is £60 after deducing the liabilities from the assets. By looking at these numbers, you may observe that the entrepreneurs' online business is doing well financially.
You run a small start-up cupcake business with total assets of £20,000 and liabilities of £10,000. By subtracting your liabilities of £10,000 from your assets of £20,000, you have £10,000 in shareholders' equity. This is the amount stockholders have available to them after paying all debts and other liabilities.
What do you learn from shareholders' equity?
Shareholders' equity is a useful tool for measuring an organisation's overall financial standing and performance. It's a good idea to regularly assess shareholders' equity, as it provides a quantifiable measure of financial health. Below are some of the things you may learn from shareholders' equity:
When finding an increase in shareholders' equity
If you discover that shareholders' equity is increasing over time, it points to several different causes, such as:
changes in asset valuation
improved retained earnings
extra capital invested by shareholders
When finding a decrease in shareholders' equity
If you've noticed a decline in shareholders' equity, it might stem from one of the following areas:
repurchasing any outstanding shares
extra treasury shares
lower retained earnings
issued shareholder dividends
How to improve shareholders' equity
Organisations typically look to constantly improve their shareholders' equity as it aligns with revenue generation and profitability. There are many different approaches to improving shareholders' equity for an organisation, such as:
1. Lower your liabilities
Getting rid of liabilities for an organisation helps to boost shareholders' equity. This means things like paying off debts or making early repayments on loans. Other ways to lower liabilities include lowering business expenses to lighten the organisation's financial burden.
2. Increase retained earnings
When organisations become more profitable, their retained earnings increase too. There are a few different approaches to this, such as cutting staff, cutting back on bonus schemes or bringing in cheaper machinery or raw materials for your products. The goal is to grow sales revenue for the organisation, which helps boost retained earnings.
3. Sell any depreciated assets
Another way to improve shareholders' equity is to inspect your existing assets to determine which ones have depreciated. This stops these assets from negatively impacting the organisation's finances and frees up the depreciated assets to sell. If all goes well, the liquidated assets sell for enough money to make a profit.
4. Increase the paid-in capital
Another option is to look to shareholders and ask them to contribute further to the organisation by providing more cash or assets. This improves each share's value and grows the investment's value in the process. When looking at the balance sheet, this additional paid-in capital increases the shareholders' equity.
Additional measurements that work with shareholders' equity
Whether you're inspecting the financial health of your organisation or trying to make a wise investment, it's useful to incorporate other measurements alongside shareholders' equity. These additional metrics provide a more accurate picture of the organisation's net worth and overall value. These additional measurements are also available on the balance sheet and include the following:
Annual reports: These are annual financial statements that include several additional details about an organisation, such as goals, leadership and culture.
Debt-to-equity ratio: This compares company assets to their liabilities and helps identify whether or not the organisation holds too much debt.
Price-to-earnings ratio: This is a ratio that compares the price of company shares to the per-share earnings, with higher ratios pointing to greater growth potential.
Industry stability and growth: This provides additional context about the organisation's environment and the potential for new opportunities and profit growth.
Dividends: Dividends indicate the stability and growth of an organisation.
Income statement: This is a comprehensive financial resource that gives you the figures to compare an organisation's earnings, expenditure and net profit over a certain period.
Disclaimer: The model shown is for illustration purposes only, and may require additional formatting to meet accepted standards.
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