Stockholders’ equity represents the remaining assets available to shareholders after a company settles all its liabilities. It can be determined by deducting total liabilities from total assets or by summing up share capital and retained earnings but subtracting treasury shares. Stockholders’ equity can consist of common stock, paid-in capital, retained earnings, and treasury stock.
Conceptually, stockholders’ equity serves as a gauge of the funds retained within a business. A negative figure could be a sign of potential bankruptcy, especially if the business has a significant debt liability.
Key Insights
- Stockholders’ equity refers to the residual assets in a business after settling all liabilities.
- It can be calculated by subtracting total liabilities from total assets or by adding share capital to retained earnings and subtracting treasury stock.
- This metric is vital for analysts and investors in determining a company’s overall financial health.
- Positive equity indicates that a company has enough assets to cover its liabilities, while negative equity could signal impending bankruptcy.
How to Calculate Stockholders’ Equity
To determine shareholders’ equity, follow this formula:
1Stockholder's Equity = Total Assets - Total Liabilities
The information required for this calculation can be found on a company’s balance sheet, comprising:
- Current Assets: These include cash, accounts receivable, and inventory—assets that can be converted to cash within a year.
- Non-Current Assets: Long-term assets that cannot be converted to cash within a year, such as investments, property, plant, equipment, and intangibles like patents.
Total liabilities include both current liabilities (due within a year) like accounts payable and taxes, and long-term liabilities such as bonds payable and pension obligations.
Understanding Stockholders’ Equity
Stockholders’ equity, often regarded as the book value of the company, originates from two main sources:
- Initial and subsequent investments through share offerings.
- Retained earnings accumulated over time through operations.
Typically, retained earnings form the largest component, particularly for long-established companies.
Stockholders’ equity can be either positive or negative. Positive equity indicates sufficient assets to cover liabilities, while negative equity means liabilities exceed assets, signaling balance sheet insolvency. Persistent negative equity is a red flag for investors, marking the company as a high-risk proposition.
Stockholders’ Equity and Retained Earnings
Retained earnings represent the company’s net income retained as additional equity capital, growing over time and potentially becoming the company’s principal source of equity. If retained earnings outweigh contributed equity capital, they dominate stockholders’ equity.
Stockholders’ Equity and Paid-in Capital
Companies finance capital purchases through equity and borrowed capital, with stockholders’ equity determined by paid-in capital from investors. An investor’s share of paid-in capital influences their ownership percentage.
Impact of Treasury Shares on Stockholders’ Equity
Companies may purchase their shares from stockholders (share buybacks), creating treasury shares, which reduce stockholders’ equity. While issued shares, treasury shares are excluded from dividends or earnings per share calculations. Companies can reissue or retire these shares based on their capital needs.
Example of Stockholders’ Equity
Here’s an example of a balance sheet for Apple (AAPL) as of July 1, 2023:
- Total assets: $335.0 billion
- Total liabilities: $274.8 billion
Stockholders’ equity: $60.2 billion ($335.0 billion - $274.8 billion)
Comparing the previous year shows a year-over-year (YoY) increase of $9.5 billion. This equity represents the remaining value for stockholders if Apple liquidates its assets and pays off liabilities.
Key Takeaways
Stockholders’ equity is fundamental for evaluating a company’s net worth but should be used alongside other financial statements, including the balance sheet, income statement, and cash flow statement.
Stick around for more detailed break downs and case studies of renowned companies to deepen your understanding of financial metrics essential for astute investment decisions.
Related Terms: Return on Equity (ROE), Book Value, Net Income, Income Statement, Cash Flow Statement.
References
- Apple Investor Relations. “Condensed Consolidated Statement of Operations(Unaudited) for Q32023”, Click Financial Statements under Q3, Page 2 of PDF.
