The three main parts of a company’s financial statement are its assets, liabilities, and shareholders’ equity. Every one of these elements is crucial for assessing a company’s financial health, which helps investors assess the long-term sustainability of the business.
For a broad understanding, the following is an explanation of shareholder equity, including its components and computation.
What is Shareholder’s Equity
A company’s net value, which is determined by the remaining assets that the company’s shareholders may claim after all of its debt has been settled, is what determines shareholder equity (SE). It is computed by deducting the entire liabilities of a business from its total assets.
In this sense, retained earnings of a business are likewise covered under SE. Instead of being distributed as dividends to a company’s shareholders, retained earnings are reinvested to support the expansion of the business.
However, a company’s liquidation value and shareholder value are not the same thing. The reason for this is because a company’s tangible asset values are devalued during liquidation, and other exceptional circumstances are considered.
Here is a look at how shareholders equity is calculated to help you better grasp what it means.
How to Determine Shareholder Equity
There is a defined equation that can be used to determine shareholders’ equity.
In this respect, the most commonly utilized shareholders equity equation is below:
Shareholders Equity = Total Assets – Total Liabilities
It is the fundamental accounting equation that is computed by the addition of the company’s long-term and current assets and by removing the total of long-term liabilities and current liabilities.
Components of Shareholders Equity
The above-mentioned formula is the basic accounting formula. The below formula can also be used:
Shareholders Equity = Share Capital + Retained Earnings – Treasury Shares
It consists of 4 parts that are applied for calculating the shareholders’ equity.
Outstanding Shares
It signifies the stocks that have been traded to stockholders but have not been reacquired by the firm. It comprised stocks that have been distributed to company officers, individual investors, corporate insiders, etc.
Outstanding shares show the stated value of common shares distributed together with the face value of preferred shares that the company offers.
Additional Paid-in Capital
Additional paid-in capital is the value paid for stocks that are higher than the stated par value. This part of shareholders equity is determined by removing the face value of every common or preference share from the price at which they were sold.
Additional paid-in capital is considered only in the case when the investor buys shares without intermediaries from the firm.
Retained Earnings
Retained earnings can be described as the amount that is preserved from the profit of the company rather than being disbursed to its shareholders as a dividend. The retained earnings of the company can be employed for clearing the debts or reallocating into the business.
In the balance sheet, the company’s retained earnings are reported under the head of shareholders equity, and it is used to know the retention ratio of the company also.
Treasury Stock
Treasury stock indicates the shares that have been bought back by the company from the investors. Companies generally used to stockpile in their treasury for future purposes with the help of selling them to generate capital at a later point in time or to defend against hostile bids.
When a company buyback its stocks, it decreases the amount of shareholders equity and is as a result listed as a negative figure under the equity part of its balance sheet.
Example to Understand better about Shareholders’ equity
Below is an example of shareholders equity with the help of the above-mentioned equation that will help in understanding better.
ABC Company’s Consolidated balance sheet
Current Assets | Dec 31st 2020 (in Rs. Lakh) |
Cash and equivalents | 2750 |
Inventories | 510 |
Short-term investments | 750 |
Receivables | 1020 |
Prepaid expenses | 2120 |
Total current assets | 7150 |
Long term assets | 4700 |
Goodwill | 3100 |
Equipment | 1645 |
Total assets | 16595 |
Current Liabilities |
|
Accounts payable | 7500 |
Short -term debt | 25 |
Total current liabilities | 7525 |
Long -term liabilities |
|
Long -term debts | 950 |
Deferred long-term liability charges | 1025 |
Other liabilities | 211 |
Total liabilities | 9711 |
Shareholders equity can be found out with the help of the above balance sheet:
Shareholders Equity = Total Assets – Total Liabilities
= Rs. (16595 – 9711) lakh
Rs.6884 lakh
Questions to Understand your ability
Q1.) What exactly does Shareholder’s Equity mean for a company?
a) The profit the company made after taxes
b) The amount the company owes to creditors
c) The company’s worth after all debts are paid off
d) The company’s cash flow status
Q2.) What’s the formula you need to figure out Shareholder’s Equity?
a) Shareholder’s Equity = Revenue – Liabilities
b) Shareholder’s Equity = Assets – Liabilities
c) Shareholder’s Equity = Liabilities + Retained Earnings
d) Shareholder’s Equity = Assets + Liabilities
Q3.) Which one of these is NOT part of Shareholder’s Equity?
a) Outstanding Shares
b) Additional Paid-in Capital
c) Retained Earnings
d) Short-term Loans
Q4.) What happens to Shareholder’s Equity when Treasury Stock is involved?
a) It increases Shareholder’s Equity
b) No change at all
c) It decreases Shareholder’s Equity
d) It turns liabilities into equity
Q5.) What is the purpose of Retained Earnings in Shareholder’s Equity?
a) To give out dividends to shareholders
b) To fund growth or pay off debts, not handed out
c) It counts as new revenue for the company
d) It is used to increase liabilities
Conclusion
In conclusion, shareholder equity represents a company’s net value after liabilities are settled, highlighting its financial health. It is calculated using the equation: Shareholder’s Equity = Total Assets – Total Liabilities. Key components like outstanding shares, additional paid-in capital, retained earnings, and treasury stock play a crucial role in this calculation. Understanding shareholder equity is vital for assessing a company’s long-term sustainability and investment potential.
FAQ's
Shareholder’s Equity (SE) is the company’s leftover value after paying off all its debts. You get it by subtracting liabilities from total assets. It’s what the shareholders would own if the company shut down and paid off everything.
It’s simple. Use this formula:
SE = Total Assets – Total Liabilities.
Add up everything the company owns, subtract what it owes, and you’re left with SE.
It’s simple. Use this formula:
SE = Total Assets – Total Liabilities.
Add up everything the company owns, subtract what it owes, and you’re left with SE.
Four main parts:
- Outstanding Shares
- Additional Paid-in Capital
- Retained Earnings
- Treasury Stock
These are the shares floating out there, held by shareholders, not repurchased by the company. Basically, it’s the total number of shares that belong to the public, insiders, and officers. It’s how you know what the company’s really worth in shares.
This is the cash investors fork out for shares above the stated par value. If you buy stock directly from the company, that extra amount (beyond the face value) goes into this category.
Retained Earnings are the profits the company decides not to hand out as dividends. Instead, they keep it to pay off debts or reinvest in the business. It’s like the company’s savings account.
Treasury Stock is when the company buys back its own shares. This decreases Shareholder’s Equity because it’s like the company’s cash is being used to repurchase what it already sold. It’s listed as a negative on the balance sheet.
Nope. Liquidation value is way lower. During liquidation, assets get sold off for less, and some oddball factors come into play. Shareholder’s Equity doesn’t consider all that, which is why they’re not the same thing.
