What is Shareholder’s Equity? How to Calculate It?
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Equity | March 30
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What is Shareholder’s Equity? How to Calculate It?

To operate successfully, every company must have some assets and in the course of business, liabilities are also accumulated. Assets, liabilities and shareholder’s equity make up for most of the financial statements of a company. These contributing factors represent the health of a company’s financial position. Assets and liabilities are common knowledge, but what is a shareholder’s equity, what it means for an equity investor and more importantly, how does one go about calculating it? Reading this piece would give you all the answers. 

What is Shareholder’s Equity?

If it comes to a point where all the assets of a particular company are liquidated and debts are paid off, the amount of money that gets back to the shareholder or the equity investor is its net equity. In other terms, it is the net worth of the said company, after the settlement of its liabilities and assets. This figure is one of the prime indicators of how the company is performing financially. Hence, it is considered vitally important by investors with a vested interest in the company. 

Also, the number of earnings a company retains, although considered in the category of shareholder’s equity, is not usually sent to the investors, through what is commonly referred to as dividend. Instead, these gains are put back into the company’s finances to advance its growth. This means that the value of liquidation of a company can not be considered the same as that of shareholders. It is primarily because, in the case of liquidation, the assets that this company holds gets automatically reduced, due to inflation and other similar factors. This is what primarily influences the decision of an equity investment by interested parties. 

How to Calculate Shareholder’s Equity?

Although many approaches can be taken towards the calculation of a shareholder’s equity, its direct implications lie in the company’s worth left after the clearance of its outstandings. One can find this information in the company balance sheets easily.

Thus, a simple formula to calculate shareholder’s equity is the following. This method is also utilized by stock fund companies to gather intel. 

Shareholder’s Equity (SE) = Total Assets - Total Liabilities 

For calculation purposes, both long term and current assets and liabilities have to be considered. Inventory, accounts or other assets that can easily be modified to cash within the time of a year can be called current assets. Long term assets, on the other hand, are assets like machinery, real estate and similar things, that can not be exchanged for cash within a year.  

Similarly, the term ‘total liabilities’ consists of the current and long term liabilities of the company. Long term liabilities differ from the current ones in their tenure of repayment. Taxes or accounts that need to be cleared within 12 months are considered current, while leases, bonds and other legal tenures to be paid-off post a year can be considered long term liabilities.

In some cases, another method of calculation that can be used by a company or stock fund  is the following.

Shareholder’s Equity = (Retained Earnings – Treasury Shares) + Share Capital

Contributing factors to Shareholder’s Equity

This method of calculation makes use of some underlying factors that make up a shareholder’s equity.

Retained Earnings

Simply put, retained earnings are the funds that a company retains from its profit, meaning this amount is not distributed amongst the shareholders in the form of a dividend. The purpose of doing so can be from growth and expansion and acquiring new assets to clearing company debts. Retained earnings can be found in the balance sheet of a company, under the SE section.

Stock Treasury

Companies purchase some shares, back from the investors to accomplish several purposes. Some of the reasons could be safeguarding these shares from entities trying to take over the company and to hold these shares for the future, in hopes of selling them at a higher price. The process of repurchasing stocks, however, lowers the equity of shareholders.

Additional Paid-in Capital

The par value of shares can be exceeded while purchasing company stock. The additional amount thus incurred, while transacting directly through the company is called additional paid-in capital. This does not apply to transactions between third parties and only applies to stocks purchased from the said company.

Outstanding Shares

Companies allocate their shares to important members of their ecosystem, such as investors, directors, senior executives and company insiders. These stocks do not get repurchased now and then, and hence, remain outside of the company purview, affording them the term ‘outstanding shares’.

As an investor, keeping a close watch on SE data for a set period can give you insights into the company, thus helping you form a good decision and investment strategy.

The Underlying Meaning

Equity investment requires at least some basic understanding of shareholder’s capital and what it signifies. For instance, an upward, positive trend year after year denotes that the company is most likely profitable. A positive SE means that the company certainly has more assets than liabilities and hence, it could be worth investing in, partly because it has enough resources to clear its liabilities. On the other hand, negative SE numbers or trends most likely represent a sinking ship. A company that has more liabilities than assets can make money in the long run, but certainly does not qualify as a favourable investment opportunity for investors looking to see their money grow. Such a company can go bankrupt a lot easier than the former category because it does not have a great asset to liabilities ratio.

Any rational individual, wanting to invest his hard-earned money would easily steer clear of such companies and rightfully so. However, SE is not the only unit of measurement of a company’s success. Other variables indicate this, as well. But it can be safely argued that SE is one of the most important markers of a company’s success trajectory.

Studying the balance sheets carefully, calculating shareholder’s equity and considering it along with other factors such as Debt-to-Equity ratio, Profit Margin and Revenue Trends would enable you to get complete information on the company’s track record.

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