What is Stockholder's Equity?
Investing in the stock market can be tricky and sensitive if you are unaware of the way to read and understand financial statements. This data reveals the financial health and well-being of the company and its status in the market. Knowing the value of assets, liabilities, annual revenue, and net profit can help comprehend the operational condition of a company. Additionally, the balance sheet also makes a difference in the shareholder’s equity. These documents give the investor a gist into the extent to which the company is worthy of investments. Let’s learn this concept in brief.
What is Shareholder’s Equity?
Shareholder’s equity is synonymously known as stockholder’s Equity. The value can be affirmative or negative, depending on the company’s overall performance. There are two financial aspects in the company’s balance that defines or determines shareholder’s equity. They are called the assets and liabilities of the company. After settling all the liabilities by using the assets, the reserved value is called shareholder’s equity.
It tells you the business’ worth in terms of equity. The positive SE expresses the favourable balance of assets after removing the liabilities from the big picture. The negative SE claims the unfavourable balance of assets that were found insufficient to meet the company's debt. After paying everything, the funds left behind are gauged as the company’s net worth.
On the contrary, the liquidated amount is irrelevant to the shareholder’s equity value. Multiple components go into ascertaining the SE value, and that includes retained earnings as well. It’s the aggregate net earnings left after subtracting dividends. The total SE is grouped into three parts: common stock, preferred stock, and retained earnings. But, in the company’s financial balance sheet, you’ll witness SE as a single figure. Retained earnings are viewed as a unit apart or by itself.
Irrespective of the shares of differences in the balance sheet, the assets side should tally with the liabilities side plus shareholder’s equity. The SE value gives investors a clear conscience of whether to invest in the company or not. No one wants to invest in a plummeting company that has a negative shareholder’s equity value. The higher the SE, the greater would be the benefit for the company, especially in terms of recovering during any unforeseen situations.
How To Compute Shareholder’s Equity?
There are different ways to calculate the shareholder’s equity. Generally, the easiest way to compute the SE value is to subtract total assets from total liabilities. The total assets consist of current assets and non-current assets. The former is highly liquid - you can sell the assets in the market and convert them into cash in no time.
Some of the examples of current assets are marketable securities, prepaid expenses, stock inventory, cash and cash equivalents, accounts receivable, and others. Non-current assets are those that cannot be converted into cash in less than one year. They are also long-term assets and are not liquid like the current ones. Some of the examples of non-current assets are goodwill, real estate, machinery, land & building, etc.
In the case of liabilities, there are current liabilities and non-current liabilities. The former are debts to be paid in less than a year. The latter are those debts dealt with after a year. Some examples of current liabilities are accounts payable, dividends, notes payable, etc. Some examples of non-current liabilities are long-term borrowings, deferred tax, secured/unsecured loans, provisions, etc.
Having covered the basics, the final part is calculating the shareholder’s equity.
The formula for Shareholder’s Equity = Total Assets – Total Liabilities.
There’s another elaborative method to find the SE value. It includes shares capital, retained earnings, and treasury stock
Shareholder’s Equity = Share capital + Retained earnings – Treasury stock.
All these components are discussed below in brief.
Other Components of Shareholder’s Equity
Investors and experts can deduce a lot of information from the shareholder’s equity. Other components amount to SE includes shares capital and treasury stock.
- Share Capital: If a private company wants to go public or expand its work operations, they invite the public and issue common shares and preferred shares in exchange for cash and other avenues from the investors. It also includes various contributions made by shareholders. Share capital is an amalgam of share purchases and other grants from the shareholders.
- Retained Earnings: This is an amass income gained by the company at the end of the fiscal year. These earnings are not for issuing dividends but instead, put to good use to pay debts or reinvest in the company. This component is added to the shareholder’s equity.
- Treasury Stock: These shares are issued by the company in the initial stage and bought back. It keeps the company away from any hostile acquisition or buyout. Plus, the company will retain the power and authority to make final decisions. These shares are subtracted from the shareholder’s equity to get the true results.
Example of Shareholder’s Equity
Infosys, an IT company, reported its annual report for the fiscal year 2020. The company shared its cash flow statements, balance sheet, P&L statement, and other financial aspects of the company. Below are some excerpts from the Infosys financial statement. Based on these figures, let’s find out the shareholder’s equity value.
Infosys Balance Sheet For The Year 2020
| Assets | Amount | Liabilities | Amount |
|---|---|---|---|
| Account receivable | $1,00,000 | Account Payable | $50,000 |
| Inventory | $2,00,000 | Debtors | $1,00,000 |
| Cash and Cash equivalent | $4,00,000 | Car Loan | $1,00,000 |
| Machinery | $5,00,000 | Other Current Liabilities | $4,50,000 |
| Total Assets | $12,00,000 | Total liabilities | $7,00,000 |
According to the formulae, the shareholder’s equity is the difference between total assets and total liabilities. So, the SE value = $12,00,000 - $7,00,000 = $5,00,000
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Frequently Asked Questions
There are different components of shareholder equity. The list includes retained earnings, share capital (common shares, preferred shares, and other contributions by the investors), treasury shares, etc.
Shareholder’s equity defines the worth of the business to the investors. A positive SE encourages investors to invest more in the company. Showcasing consecutive negative SE values disrupts the company’s brand image, thereby resulting in the fall of the beginning. The list of things included in Shareholder’s Equity is current assets, non-current assets, current liabilities, non-current liabilities, retained earnings, paid-up capital, treasury shares, common shares, preferred shares, share capital, etc.
The basic formulae to calculate shareholder’s equity is the total assets minus the total liabilities. Another way to compute the SE value is the share capital plus retained earnings minus treasury shares.